Standard Approaches to Refinancing
While many people purchase a home with the intention of just getting a mortgage on it and paying it off over the years, and not adding on to it later, life is just not always that simple. If one was completely committed to a plan like this, and wished to execute it successfully, this would mean that over the life of the mortgage they would never take on any new debt.
This does not mean just not taking on large debts or a significant amount of debt, it really means literally no debt at all. As fine as an ambition as this is, if you ask these people whether or not this is what they are looking to do, very few people would admit that this is something that would ever be foreseeable for them.
Taking out a mortgage to buy a home is just one of many borrowing experiences that we typically go through in our lifetimes, and for a lot of people, they are borrowing more often than not, especially in the first half or two thirds of their careers.
The plan may be to one day get to the point where they are not borrowing anymore, but unless one is already at this stage and expects to remain there, there will be borrowing. With this the case, we then need to look at borrowing at as low an interest rate as possible.
Debt secured by home equity provides the best rates, so the goal then needs to be to take advantage of this home equity as much as possible, to pay these lower rates on our debts as much as this equity will allow.
Any time we set up a new secured product, there will be costs involved, and at a minimum this requires paying for the services of a lawyer, as this will involve things like a title search and registering the secured product. There may also be other costs involved, and the interest savings will need to exceed the costs involved in refinancing the debt for this to even make sense.
At best, when it costs us money to refinance debt, this is going to result in inefficiencies, no matter how much money in interest we save. If we save $30,000 from refinancing, and it costs us $1000 to pay for it, we’ve still lost this $1000 in comparison to being able to refinance the debt without any cost.
With just our standard mortgage, there is no way to be able to refinance other debt by using our equity without spending some money. Even if we just look to set up a secured line of credit later, there are costs involved in doing this, because this is going to involve a lawyer.
Should the line of credit that we add not be sufficient later on, we also may need to pay out and discharge it, and set up another, larger one, and all this involves further legal fees.
If we instead pay out our existing mortgage and take out a new, larger one, this is going to cost some real money as well. Again, even though doing so very often involves big savings, ideally we could add debt to our mortgage without having to go through these additional processes and expenses.
Collateral Mortgages Build In the Ability To Borrow More
If we instead choose to go with a collateral mortgage, while we cannot ever add any additional charges to it, there also is much less need to do so, as we can often just borrow these extra amounts, and take advantage of our additional equity, without having to do anything or spend anything.
Lenders also may have the ability to register more than what you paid for the home or its value at the time of the mortgage, so if your home goes up in value in the future, and you need to access some of this additional equity, you may be able to go beyond this initial value, without having to refinance your mortgage.
When lenders register a collateral charge on a property, what this essentially means is that they have a legal claim to this much should it be owed. In our above example, the purchase price was $100,000, you borrowed $80,000 initially, but the lender may register a charge of $125,000 on the property. This gives them the ability to lend this much to you later should they choose without your having to break the original mortgage and pay for a new charge to be registered.
Should you need to go beyond that, then a refinance and additional legal fees and other costs will be involved, as they are with refinancing standard charges. This is required in all cases where standard mortgages are refinanced, but collateral mortgages give us much more leeway and allow quite a bit to be added on to them before this becomes needed.
How Collateral Mortgages Function
Provided that the terms of the collateral mortgage are suitable and competitive, as they often are, collateral mortgages can be a great idea. How these work is that they are structured as a hybrid product, with both a loan portion and a line of credit portion.
In our example, we would be starting out with a loan portion of $80,000 and a line of credit portion of 0. As we pay down the principal on the loan, let’s say the current balance if $60,000, this means that we could borrow up to the remaining amount, $20,000, on the line of credit portion, or even more, depending on the structure of the collateral mortgage.
Therefore, the entire borrowable amount is always available to us, instead of having to refinance it or add a fixed amount of a line of credit later. Not only does this line of credit built into a collateral mortgage offer more flexibility, as it automatically increases relative to our original loan to value, we may also have the ability to apply to increase it as our property value increases, if we need to, all without having to refinance.
While some complain that these increases are subject to credit approval, any addition of new credit is, and if one’s credit falls upon the rocks, they aren’t going to be borrowing money at prime rates anywhere. However, collateral mortgages may allow for one’s credit line to increase without any further credit checks, which isn’t the case when you’re looking to apply for new credit otherwise.
While collateral mortgages definitely do have their upsides, especially with people who do plan on using credit in addition to their mortgage, there are some downsides as well.
One of the criticisms is that by allowing people to access up to the original mortgage amount at any time, or more, this can lead to additional borrowing that perhaps would not have been made if these funds were so readily available.
Many people who ponder the drawbacks of this don’t realize that, with credit so readily available, it is far less likely that having more available credit on a collateral mortgage will have any real effect on the extent of one’s borrowing.
If one has the desire to borrow more, and one is at least minimally credit worthy, one will encounter little resistance to getting new credit products, especially new credit card products. Most people already have the means to get themselves in a whole lot of trouble just by using the borrowing power they already have, without even applying for new products, and the rates they will pay far exceed that of a collateral mortgage, by several times typically.
One must have the responsibility to manage credit well, and if they do not, over-borrowing on their mortgage is actually preferable than doing so with things that cost a lot more in interest.
The other major criticism is that it is a lot more difficult to change lenders with collateral mortgages, and this one has some truth to it. Once one’s mortgage term is up, one can shop around and either find a better deal elsewhere or use this shopping to get a better offer from one’s current mortgage lender.
This is because standard mortgages are usually transferable, at no cost, but this isn’t the case with collateral mortgages.
Generally, you can only shop around at lenders who offer collateral mortgages to pay out your current one, and even if you do move it, you will pay the full cost of refinances. So even if the bank down the street is offering you a better rate, your bank will know that you can’t do it for free and they will have to beat your current deal by more than that for this to ever make sense for you.
This of course only comes up when your term comes due, but this does result in less bargaining power. Banks will not just offer you better deals out of the goodness of their heart, and are known to be a whole lot generous when they feel that they are the only lender competing for your business.
Even so, collateral mortgages can be well worth considering. One can still manage a mortgage and a line of credit separately though, so while banks love collateral mortgages, just because your bank offers them doesn’t mean you should just take the deal, although in some cases they do indeed make sense.