A few weeks ago I published an article on my concerns regarding collateral mortgages. I outlined why I think they are problematic for many consumers and how they are risky for second mortgage investors.

Two bankers responded. One was very negative whereas the other took a moderate approach and shared some interesting points. Let’s start with the latter.

Banker #1

Steve (not his real name) is a friend of mine whom I’ve known for several years. He is a banker at an institution that deals in both conventional and collateral mortgages. According to Steve, collateral mortgages are becoming standard practice. He wrote the following:

“Good article.

All good points.

With a collateral mortgage, yes, the bank can more easily increase borrowing to the client.

And you can insist that the registration is only for the amount borrowed.

The bank does not own the equity, the client does. (Doris’s note: My original post had a phrase that was unclear on this point so I amended it. My thanks to Steve for helping me to fine-tune the language.)

The issue is if the client owes 80% on their mortgage, 10% on their LOC, 10% on a car loan and 5% on a credit card with the same bank. Then, there would be no equity for the client/investor. If, however, the client just has an amortised mortgage with a decreasing balance and no other lending at the bank, and the property value is increasing, then there is still equity if things go downhill.

Also as a second mortgage, or any lean (sic) on the home, you are still protected, as all leans have to be discharged (in rare cases agree to be postponed – never saw this happen)  before other financing can be put in place (sale or new first mortgage). So if the client has assets within the home or in other places, you can be paid. Even in a bankruptcy, you are a preferred creditor, so would be settled before credit cards etc.. unless held at the bank with the 125% registration.

Your point is well taken: best to avoid investing in second mortgages when there is a mortgage registered for 100% of value of home. There are other deals to be had where you don’t have this concern. In some cases however, it might not be as bad as you put it, IE: Short term, help the client out and they have stable jobs, decent investments etc….

Just a thought.”

Steve’s point

Steve feels that collateral mortgages may be beneficial for clients if a) they end up needing more funds down the road and b) their credit is in good shape and c) the value of the house has gone up. While that’s true, it still doesn’t address the point that many collateral mortgages (if not most) make it more challenging and expensive to change lenders if you decide that they are not meeting your needs. It also doesn’t help out consumers who have experienced credit difficulties and who find themselves in need of cash but are unable to obtain it from their existing lender. In the latter case, they’re stuck.

And what if the value of the house doesn’t go up, as is the case in a number of markets in Canada at the moment?

House value

In 2008-2009 several of my properties in Alberta actually lost value on paper and some still have not recovered their value six years later. In Ottawa, at the moment, there are multiple areas showing stagnant growth and even a reduction in value. What is the benefit of a collateral mortgage then? Assuming the value of the house hasn’t dipped below the original purchase price, the clients are now left to rely on the equity built up as they pay down the mortgage. A quick look at any amortization schedule will show that the amount of mortgage pay down is negligible in the first years of home ownership; you pay a lot more in interest than principal. So in this case if you do end up needing money later on, you’d better hope that you don’t need too much or need it too soon.

I take Steve’s suggestion that collateral mortgages may be helpful in some cases but my overall point remains: the risks may outweigh the benefits in many cases. With respect to second mortgages, Steve and I have agreed to disagree about the risks involved. As a second mortgage investor, I simply won’t touch properties that have a collateral first mortgage.

Disclosure?

I would have no problem with collateral mortgages for consumers if lenders properly and fully explained the pros and cons to clients as they make a decision about the best course of action for their family. Clients could then make a decision based on facts.

The CBC’s Marketplace program recently did an undercover investigation (segment starts at 15:46) into collateral mortgages by sending some people into different branches of one particular bank to ask questions. The results were not surprising to me: the banking representatives in the segment had no clue about collateral mortgages, and in some cases they passed on inaccurate and misleading information. They clearly did not fully understand the product nor did they properly advise the prospective clients. While the segment only focused on one bank, it could easily have done this at any bank offering collateral mortgages.

This is borne out by conversations I’ve had with lawyers (see Part 3 of my series on collateral mortgages). In short, clients are not being fully, accurately and properly advised about the pros and cons of collateral mortgages, nor is the documentation very clear.

My experience

In my own case, for one of my investment properties, I discovered that the bank sent me documents for a collateral mortgage. There was no call from the bank to discuss the type of mortgage on offer, nor did the documents make it clear. The cover letter simply said the obvious: Here are your documents, here is the rate that we’re offering , please sign here and get it back to us in this way. There was not a word about collateral mortgages in that letter. I discovered what was in play by digging through the documents and seeing a reference to a registered charge for the full value of the property.

It’s these kind of practices that give banks a bad name. If the banks want to avoid attacks in the marketplace, then it behooves them to make a few fundamental changes:

1. Provide full and complete disclosure of the good, the bad and the ugly of collateral mortgages. Be up front about what the potential challenges and pitfalls are as well as the benefits.
2. Ensure that the clients understand that the bank will not automatically grant access to additional funds. They still need to qualify by maintaining a good payment record, good credit score, etc.
3. Provide trained, knowledgeable staff who actually understand the product from top to bottom. There is no excuse for the kind of stuff we saw on Marketplace.
4. Make it clear on websites and in all literature that there are two kinds of mortgages, which ones you offer and the pros/cons of each.
5. Have I mentioned full disclosure?

 Banker #2

This one is more interesting. A friend sent me a link to one of her social media sites and told me to check out a comment about my blog post. She had shared my post because she felt it would be valuable to her readers. One banker responded with the following:

There are several false statements in this article which shows either the writer does not understand her topic or perhaps is trying to create fear for personal gain.

…not all collateral charges are registered for 100% of the home value and even if it were, which they are in some cases, if the client needs access to some of the available equity, the registration can be changed. The article gives the impression that you are in big trouble and cannot access remaining equity, there is no value left in the house to protect your investment? C’mon…what do you think the average consumer will do when they read this? Panic and envision their investment going down the toilet. Secondly the word collateral charge is all over the documents and the client pays their lawyer for a reason…to protect them. If some over zealous bank employee has asked for the charge to be registered at 100 or 125% without discussing it with their client, I would HOPE their lawyer would have the discussion with the client.

Three comments:

First, I reached out to the person who wrote the above comments offering to interview them to discuss their concerns. I promised to post our conversation to present their views. I gave my contact information. The person asked about my availability for a discussion; I gave dates and times. I have not heard back from them.

Second, none of the lawyers I spoke to had ever seen registrations for less than 100%. In my own experience, I have seen registrations for 100% and 125%. Off-the-record discussions with two of the Big 5 banks confirmed that 100% is standard practice for their institutions. An employee at a third bank confirmed that 125% is their standard practice.

Third, every lawyer I spoke to confirmed that it is typically too late to make substantive changes to the mortgage by the time they receive the documents. The lawyers also noted that clients do not have sufficient information about collateral mortgages to understand the consequences. In many instances their clients have no idea that they are taking on a mortgage that differs from a conventional mortgage.

Buyer, educate thyself

We are all familiar with the saying, “Buyer beware.” Given what I’ve seen, I’d like to add the following: Buyer, educate thyself.

And thanks for your comments Steve. If only all bankers were more like you.

Part 1 in this series: Why You Should Stay Away From Collateral Mortgages

Part 3 in this series: Collateral Mortgages – What the Lawyers Said