What is a second mortgage? 5 tips you need to know
18 May, 2018 / by Glenn Carter
If you are new to the homebuying process, there are numerous things for you to consider and research. In many cases, you will become accustomed to different terms, definitions and standards when it comes to home buying and mortgage loans, but it can take time. Even for experienced homeowners, understanding all the facets of mortgages can be challenging.
In certain circumstances, you may even have to think about getting a second mortgage. This is a mortgage typically taken out by homeowners who need cash for emergency repairs, working capital for business or investments, renovations, funding education, paying for a wedding, or even to consolidate other debts and lines of credit.
Let’s take a closer look at exactly what is a second mortgage, and what it means to you.
An overview of second mortgages
A second mortgage can mean two things: a mortgage you take out on a second home, some refer to literally as a second mortgage, and a mortgage which sits on top of a primary mortgage. The latter is the most accurate use of the term second mortgage, and is what we will be discussing today.
In this sense, a second mortgage is not a mortgage you get on a new home — it’s actually a secondary mortgage that you can take out on your existing property.
Second mortgages extract equity from a home, which allows homeowners to access capital when they need it. The basic form of second mortgage comes in the form of an lump sum loan.
With a standard equity loan, you can borrow up to 85 percent of the value of your home in major cities in B.C., Alberta, and Ontario. For most other cities in Canada, the maximum is typically 80 percent.
Over time, you will pay off the entirety of the loan and the interest, much like you would with a car loan. Regardless of the loan option you pursue, you should make sure you understand all the intricacies of second mortgages before getting started.
How a second mortgage works
What is a second mortgage and how does it work? As we mentioned above, a second mortgage is a secondary loan you can take out on top of your current home mortgage. They are typically held by a different mortgage lender than the one who lent you your primary mortgage. Getting a second mortgage enables you to access equity from your home without making any changes to your primary mortgage.
The distinction between primary and secondary mortgages is an important factor to keep in mind. Rather than simply increasing the principal of your initial mortgage loan, second mortgages have their own terms, rates and rules, which means you pay it off independently of your primary mortgage. When you get a second mortgage, you will continue to pay your primary mortgage, along with additional mortgage payments for your new loan.
Before you can apply for a second mortgage, you will need to find out how much equity you have in your home, your home’s value, and your credit score. All of these details will affect your ability to secure a second mortgage, and they also influence second mortgage rates and terms.
Next, you will need to shop around for the best rates from various banks and lenders. As always, it’s best to partner with a knowledgeable mortgage professional who tailor a loan product to your specific needs.
After choosing a lender, you will fill out an application for a second mortgage. If you are approved, you can review the terms of your loan before signing an agreement.
In many ways, applying for a second mortgage is similar to applying for a primary mortgage. A major difference, however, is that second mortgage rates are typically higher than those associated with primary mortgages. This is because lenders that offer second mortgages typically have to assume more risk of delinquent payments or loan defaults.
The higher interest rate is also a result of the primary loan taking precedence over the secondary one. For example, should there be a forfeiture, the secondary lender will only get money after the primary one is paid in full. This makes secondary lending riskier.
Second mortgages can range greatly, but a borrower with good equity and credit history could get a 6.99% or 7.99% rate. While this may seem high, it’s low compared to most unsecured credit lines and credit cards
Below you will find some tips when it comes to second mortgages:
Tip #1 – Second mortgages are commonly used for…
Individuals and families may face a variety of circumstances that might lead them to consider a second mortgage loan. Generally, those who apply for a second mortgage do so out of necessity because they need capital quickly. In the interest of freeing up financial resources from home equity, they will assume the higher rates that come along with a second mortgage.
The following are some of the most common reasons people apply for second mortgages in Canada:
- Working Capital: Getting access to your home equity is a primary funding method for those looking for working capital. This can include opening a new business or funding a current one, investing in businesses, retirement, or real estate, and any other forms of investing that requires a lump sum of capital.
- Debt consolidation: If you have several loans and lines of credit from various lenders, banks or agencies, the payments, loan terms and interest rates may overwhelm you. When you have to concern yourself with numerous loans, you may be more likely to miss payments or pay excessive amounts of interest. A second mortgage loan allows you to pay off debts and consolidate loans into one manageable mortgage agreement.
- Renovations and repairs: It is common for home appliances and roofs to fail unexpectedly and necessitate emergency repairs. This kind of work on your home can be costly, and you might not have much time to save money for the repair. In other situations, you may simply want to make an improvement to the appearance or function of your home. Whatever the reasons, a second mortgage could allow you to finance these improvements.
- Avoiding high penalties: Finally, a common use for a second mortgage is people who may have a first mortgage with a low rate locked in, and their penalty is high to break in order to access funds. It is far cheaper to get a 1-2 year second mortgage than pay a high breakage fee. This can provide access to funds for debt relief or investment capital. When the first mortgage matures, the two loans can then be blended into one.
Tip #2 – Helps those with bad credit
One of the top benefits of second mortgages is that it is possible to get one even if your credit history is mediocre or poor.
If you have paid off a significant amount of your primary mortgage loan, you have a record of making consistent and on-time payments and you have a lot of equity in your home, a lender may overlook your credit score (within reason) and approve you for a second mortgage.
Because a lender evaluates your suitability for a loan based on your equity and track record with your primary mortgage, you may even have an easier time getting a second mortgage than you would a standard loan—assuming you have been making your payments on time and you have plenty of equity.
Second mortgages are also a great way to clean up bad debt, such as high interest consumer debt, debt that is in collections, or even tax arrears.
Tip #3 – Private lenders are often more flexible
All federally regulated banks must operate within certain laws and guidelines. These rules reduce risk for the lender, but they often cause them to overlook reliable borrowers simply due to minor disqualifications.
Because every person is different, it’s important to ensure that your case is examined individually so that you have the best chance of getting the loan you need at a fair rate. To accomplish this, your best course of action can be to work with a private lender.
A private lender is a business—rather than a traditional bank or financial institution—who agrees to finance your loan. In the past, private lending was equated with individuals loaning out money at high interest rates. Although some still do this, private lenders include professional organizations, like CMI, who can offer a variety of loan products at competitive rates.
Tip #4 – Common costs associated
As with any loan, you may be subject to additional fees, including closing, legal, and appraisal fees.
When it’s all said and done, you may be on the hook for several thousands of dollars worth of fees, so make sure you know what to expect from your lender before you sign anything. This is why it’s important to work with an experienced broker who can guide you in the right direction.
Tip #5 – Know how to find a second mortgage (talk to a professional)
Financial choices are not always totally clear, and it’s important that you examine all the options available to you to determine which decision is best for you and your family.
As a general rule, you should not make a big decision about your finances if you feel pressured or rushed. That said, you are considering a second mortgage because you are in a tough financial spot, and likely need some quick cash. This why it’s so important your partner with a knowledgeable and reputable broker to help guide you through the process in a timely manner.
Considering that there are so many different factors at play when it comes to second mortgages, you also shouldn’t attempt this process on your own. Look for guidance from a mortgage professional who you trust and who is looking out for your best interests.