One way by which Canadian homeowners can access cash without selling their property or refinancing their current mortgage is through a second mortgage. It can be used for consolidating debts, home improvements, funding businesses, investments, and even for educational purposes, among others.
Even as a second mortgage can provide you with some benefits, it is a mortgage after all. Hence, it would make sense to get familiar with its costs, repayment structure, and the risks involved.
If you are interested in applying for a second mortgage in Canada, then you should consider these 10 important facts first.
What Is a Second Mortgage?
It is an additional mortgage loan on a property that is already mortgaged. This means that you will still have to pay for both mortgages until you complete them.
Since the second mortgage is subordinate to the first mortgage, there are higher risks for the lender. Consequently, second mortgages come with higher interest rates compared to the first mortgages.
How much one can borrow from the mortgage will depend on several factors, including the value of the property, existing mortgage, equity, income, credit, etc.
10 Things to Know Before Getting a Second Mortgage in Canada
You Must Have Sufficient Home Equity
The first consideration that most lenders would take into account is your home equity. This is basically the difference between the value of the property and what you owe for your mortgage.
The amount of equity that you have affects the amount that you could possibly borrow from your lender. According to FCAC, one could borrow up to 80% of their home’s value using home equity borrowing, provided that the exact amount depends upon the type of product used and the lender.
A Second Mortgage is not the Same as Mortgage Refinancing
Even though these financial products give a chance to get some more money, mortgage refinancing and a second mortgage are different.
In the case of refinancing, you usually refinance an existing mortgage with a new one and sometimes for a larger amount. In a second mortgage, you retain your existing first mortgage and take a new loan on top of it.
It may be critical when your current first mortgage has attractive rates because refinancing will require giving up those rates or paying a penalty for breaking a mortgage contract.
According to FCAC, early termination of a closed mortgage may lead to a prepayment penalty, which might amount to thousands of dollars.
Anticipate Higher Interest Rates
The first point of consideration in obtaining a second mortgage is that you should expect a higher interest rate than what you have in the first mortgage.
The logic behind this is straightforward; second mortgage loans are riskier because, in case of foreclosure, they are always secondary in terms of claims on sale proceeds. As such, higher interest rates will most likely apply to such loans.
While higher interest rates don’t automatically mean that second mortgages are not good deals, there might be a case where such second mortgages become more advantageous than other borrowing alternatives.
In no way should you compare loans based on the monthly payments.
Your Credit Score is Important
A good credit score may increase your likelihood of securing a second mortgage and better loan terms.
In the course of loan approval, the lender may consider such factors as your credit rating, total debt, income level, payment record, and financial state. Better scores may result in more favourable loan terms; credit issues may create certain restrictions.
Before applying, look through your credit report and ensure that there are no errors.
You Will Have Two Mortgage Payments
The second mortgage won’t replace the first one. You will pay off both mortgages since you have two mortgages; the first one and the second one.
This is important because you will have to be sure that both monthly costs fit within your budget.
Know the Total Cost of Fees
Interest rate isn’t the only charge. There could be some other charges depending on the institution and transaction. The other costs may include appraisal charges, legal charges, title search charges, title insurance, administration charges, and closing costs.
According to FCAC, some of the costs involved in borrowing against the value of your home include appraisal fees, title search fees, title insurance, and legal fees.
It is important to ask for an estimate of all costs involved.
Understanding Your Reason for Borrowing
Before borrowing through a second mortgage, think about how your reason for borrowing can justify the added expense.
The purpose is important since not all reasons would add value financially and can possibly just add to your debt burden without bringing you any financial benefit.
Be Prepared for the Risk to Your House
This might just be the most important point. The second mortgage is taken against your house. If you don’t pay off the amount owed, you might be facing some very dire consequences, which could even include the loss of your house. In fact, the FCAC says that borrowing money through home equity can involve the risk of losing one’s house in case of non-payment of the loan.
Comparison of Second Mortgage with other Options
A second mortgage isn’t the only option to take advantage of your home equity. Other options, depending on your situation, could be:
Mortgage Refinancing: You could consider replacing your existing mortgage by getting another mortgage that allows you to borrow extra money.
HELOC: Home Equity Line of Credit, which would let you draw money as many times as necessary within the approval limit. According to FCAC, a HELOC might usually offer the possibility to borrow up to 65% of your home’s worth.
Home Equity Loan: Allows you to borrow money in one lump sum amount.
Unsecured Personal Loan: This option is good if you don’t need to secure more debt on your home.
Debt consolidation: If the debt with a high interest rate is the major concern for you, compare the cost of consolidating the debt in various ways.
Consider the Full Picture, Rather than Just How Much Cash Will Go into Your Wallet
It can be quite easy to look at the amount of cash flow generated by taking out a second mortgage. However, think about what else is going on. Take the following into consideration:
How much will I end up paying back for the duration of the loan
The fact that one loan has a lower monthly payment doesn’t mean it will cost less if the duration of the repayment is longer. The FCAC warns that increasing the amortization period will have a substantial effect on the interest charges.
Before making a decision to take out a second mortgage, do a full comparison of the total interest, fees, monthly payment, term, and possible penalties on repayment.
When a Second Mortgage Would Make Sense?
A second mortgage would be appropriate when the amount of equity is adequate, and a necessity exists for the borrowed money. In such circumstances, a second mortgage can be particularly helpful when you have a good deal on your current mortgage and do not wish to refinance.
For example, in the event of a low-interest mortgage and a requirement to repay something expensive, a second mortgage may give you access to your equity without the refinance of your existing mortgage.
However, increased costs and additional payments must be considered.
Procedure for Getting a Second Mortgage in Canada
While the procedure may differ from one lender to another, you will likely have to give details regarding your house, your current mortgage situation, salary, debt, and financial standing.
An appraisal may be required by the lender to find out the current value of the property.
Things to do before applying:
· Calculate your home equity.
· Look at your credit score and your debts.
· Calculate the amount of money you really need to borrow.
· Compare different second mortgage companies and loan options.
· Know all the fees and penalties.
· Calculate total borrowing cost.
· Ensure that monthly repayment is within your budget.
· Review the deal before signing the agreement.
It may also be useful to use the services of a mortgage expert in order to evaluate various financing deals, not just loans.
Searching for a Second Mortgage in Canada? EverLend Can Help
When you are looking for a second mortgage either for utilizing home equity, paying off debts, buying something big, or for anything else, EverLend can help you in evaluating your chances of getting your mortgage financed.
Each homeowner has their own set of circumstances. Your present mortgage interest rate, home equity, income, credit score, and other factors can influence your choice of which would be the best choice for you. EverLend gives you customized mortgage financing solutions, providing Canadian homeowners the opportunity to review their mortgage financing options.
If you have any doubts about whether or not taking up a second mortgage or refinancing is the best choice for you, feel free to get in touch with EverLend and evaluate your choices.
Conclusion
Second mortgages allow people to access their home’s equity without having to pay off their current mortgage; however, people shouldn’t consider a second mortgage as cheap or easy money.
People need to know beforehand how much equity they have, what interest rate they will get, how much their payments will be, and what costs they will have to incur. What they must realize above all else is that they will be using their house as collateral on the loan.
People should compare second mortgages to other financing methods such as refinancing methods, home equity line of credit (HELOC), and home equity loans. A mortgage professional can advise on which type of financing is best based on people’s financial plans.
Frequently Asked Questions
Is a second mortgage a good choice in Canada?
It can be a good choice for borrowers who have enough equity and have a specific need for the loan, but the increased interest rate and extra payment should be taken into account.
How much can I borrow through a second mortgage?
The amount of a second mortgage depends upon the home’s value, current mortgage balance, equity, income, credit profile, and lender’s requirements.
Can I qualify for a second mortgage with bad credit?
Borrowers with certain credit challenges may be able to obtain a second mortgage with certain conditions, including different rates.
Can I get a second mortgage to consolidate loans?
Yes, homeowners often take out a second mortgage to consolidate their loans at lower interest rates.
Can a second mortgage affect my credit score?
Yes, a second mortgage may involve a credit inquiry that ultimately affects the credit score.