The collateral: what you put into your mortgage

The collateral on your mortgage is very closely related to the down payment you make and it plays a big part in deciding for which type of loan you qualify.

This page:

  • Explains what factor make up the mortgage collateral

  • Describes how lenders treat mortgage collateral when making decisions

  • Helps make clear what you need to do in terms of money down

On this page we'll examine how your collateral affects your mortgage approval. The previous pages dealt with credit capacity and your credit history.

The second part of this guide examines the rest of the decisions you'll have to make when choosing your mortgage. Refer to the table of contents if you're looking for specific information.

How much collateral are you putting into your mortgage

Mortgage collateral is related to the issue of savings and credit capacity. Lenders look at this carefully to judge how serious you are about this new financial commitment.

The mortgage collateral simply refers to how much money you're willing to put into buying your new home. More specifically, in this case, it's used to refer to cash down per value of your home. (It's kind of the opposite of the LTV, or loan to value ratio; think of it as a non-loan-money to value ratio.)

Most consumers think strictly in terms of total money down. This is a flawed way of thinking, because what's important to your lender is the percentage down. As we discussed in the section on down payments, 20% down is the traditional standard that avoids private mortgage insurance and gets you a prime rate.

However, a very expensive home requires a really big down payment, because lenders may require even more than 20%.

A lender wants to see that you're committed to your mortgage. The larger the mortgage amount, the more commitment they want to see. Your willingness to invest early, or build collateral, makes them more willing to overlook other possible flaws in your credit profile - like low income or self-employment. You're simply less of a credit risk when you're willing to put a lot of money down.

One thing that factors into questions of mortgage collateral is the property itself. Lenders are more likely to lend you money if property values in your chosen neighborhood are going up, and they're more likely to lend if the property is a single family dwelling in which you will be living. Both of these factors decrease the risk of lending to you.

If the property appreciates in value, you won't be as likely to default on your loan (and if you did the bank wouldn't have as hard a time reselling it and recouping their losses). If it's your family's home, you won't want to lose it either.

On the flip side of the coin, lenders aren't as pleased if the property is in a depreciating neighborhood, if it's a two, three, four, or more unit dwelling, a condominium, or if you intend to use it as a rental property. All of these factors tend to increase the investment risk to them.

This brings us to the end of this do you qualify? section of the choosing a mortgage guide. If you are ready, apply for pre-approval now, or go back to the index and follow the links to more valuable information about how to pick the best mortgage for you.

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