Collateral Charges: Hidden Costs of Home Buying

A growing number of banks, credit unions and other Lenders are using something called a collateral charge when setting up your mortgage, often without you even knowing. What exactly is a “collateral charge” and how does it impact you?

In simple terms, a “collateral charge” is the way your bank registers your mortgage. Unlike a “standard charge” which mirrors your actual mortgage balance, a collateral charge does not decrease. For example, if the bank registers a charge of $300K on your home it will remain at $300K despite the actual mortgage balance being paid down each month. The reason lenders give for doing this, is to make it easier for you to obtain secured funds should you need to borrow against your home in the future.   Rather than having a lawyer register a new mortgage charge for the funds, you can use the existing mortgage. In theory it sounds like a good idea, but in reality it creates more problems than it solves. How?

Suppose you want to switch lenders upon maturity of your term. Normally this would not cost you anything, provided you are not making any changes to the loan amount. With a collateral charge, however, this is not the case. A standard charge can be transferred to a new lender, but a collateral charge MUST BE DISCHARGED and a NEW CHARGE SETUP with the new lender. Switching lenders now becomes a costly proposition, costing you around $1,500 in legal and appraisal costs.

Another example is say you want to obtain secured funds but the current lender refuses. Based on the value of your home and the balance of your mortgage there may be sufficient equity to work with, but with a collateral charge, that equity will likely not be accessible since it is tied up with the collateral charge!

Many lenders are using collateral charges, but there are still lenders that don't. It’s critical to know what type of charge your bank is registering. Often, this is not fully explained upon signing and you will be unaware until you try and switch lenders at the end of their term or try to setup secondary financing and are shocked to learn you can't. Make sure you work with a mortgage professional that FULLY EXPLAINS all the terms and conditions of your mortgage before you sign on the dotted line.