It is good news to hear that house prices in your neighbourhood are rising. The rising house prices mean the equity in your house is also increasing. You can convert that equity into liquid cash to finance your dreams. But you’ll need a second mortgage to access the liquid money without selling your house or refinancing your existing mortgage.
This guide covers the ins and outs of a second mortgage to help determine if it is the right mortgage type for you at this time.
Let’s start by understanding what a second mortgage is.
A second mortgage is a loan that takes the second position claim on the collateral of your home.
The second position indicates how the loan is registered against your home, prioritizing how it will be paid off in a worse-case situation.
If your home must be foreclosed, the second mortgage will be paid only after the first mortgage is paid in full. The second mortgage loan may not get paid if the reclaimed money from the foreclosure is not enough to pay off the entire first mortgage balance.
You can get a second and a first mortgage simultaneously or at different times.
For example, your mortgage lender might not be willing to finance the entire loan to help you purchase your home. In that case, the lender may allow you to get another lender to come for the second mortgage to help share the risk. Both mortgages will be registered on the closing day with different priorities – first and second.
You can also get a second mortgage long after the first mortgage is registered. Let’s say you have a first mortgage already registered on your house. With enough equity in your property, you can get a second mortgage from another lender or even from the same lender as your first mortgage. The second mortgage will be registered in the second position.
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Second mortgage loans help homeowners cash out the equity accumulated over time in their property. This money can consolidate debts, take on capital-intensive projects like home renovation, purchase additional properties and more.
But to get a second mortgage to do all these things, you first have to apply to get the money from the lender. Your ability to access a second mortgage will depend on the equity you have in your property.
The second mortgage adds to the existing mortgage secured against your property. The combined loan amount is still assessed relative to the property’s value. You will hear the phrase “combined LTV.” It is just a fancy way of describing the total mortgage loan you have secured against your house to the value of your home.
Most mainstream lenders will only allow you to have a total loan-to-value ratio of 80%.
For example, let’s say the market value of your property is $400,000. You have a mortgage in the first position with a balance of $260,000.
The LTV for your first mortgage is 65%.
Meaning you have 80% – 65% = 15% equity in your property to access with a second mortgage loan
The second mortgage does not necessarily have to come from a separate lender. Some lenders offer first and second-mortgage solutions. But the two mortgages will have different terms, conditions, and interest rates.
Payments for the first and second mortgages will be withdrawn from your account as two separate transactions, probably at different times.
You can apply for a second mortgage directly with your bank or through a mortgage broker.
Like any other type of loan, there are pros and cons to taking out a second mortgage.
The second mortgage program allows you to access the equity locked up in your property. With a second mortgage, you can access up to 80% of the equity of your property. A private lender may even allow you to borrow up to 90% of the value of your property.
Reasonable Interest Rate
Interest rates on second mortgages are much lower than those on credit cards and some personal loans. Because a second mortgage is secured against your home, its risk is lower than unsecured debts. This explains why lenders are willing to offer attractive rates compared to other unsecured debts.
Some loans will restrict the usage of the funds. For example, most first mortgages require you to use the money to either pay out the property seller or the existing mortgage lender. However, a second mortgage does not have those restrictions. This makes a second mortgage a more flexible loan option.
Compared to first mortgages, interest rates on second mortgages are much higher. There are second mortgages with interest rates as high as 14%. The risk to a lender in a second position is higher than a lender in a first position. The second mortgage lender tends to offer higher interest rates to compensate for the increased risk.
The required payments for the second mortgage loan may stress your finances, putting pressure on your budget. You will be making payments to two separate lenders, which might easily lead to a missed payment and, thus, a default if not managed carefully. It can also be tough to address these two payments if you live paycheque to paycheque.
Home equity loans allow homeowners to borrow money against the equity in their homes. Your home equity is the collateral that secures the loan with a home equity loan.
This type of the second mortgage has most characteristics of a first mortgage amortized over 25 years or 30 years. The mortgage rate is fixed or variable, and the payment frequency can be monthly, bi-weekly, or weekly. Also, the payment structure is interest and principal.
You may borrow up to a combined loan-to-value ratio of 80% of your property’s value. Your home equity is the difference between what you owe on your mortgage and what your home is worth.
For example, if you owe $400,000 on your mortgage and your home is worth $600,000, you have $200,000 in home equity.
In Canada, lenders cannot lend more than 80% of your property’s value. Therefore, for a $600,000 house with an outstanding first mortgage balance of $400,000.00. The maximum home equity available for you to borrow is
A Home Equity Line of Credit (HELOC) is another form of a second mortgage loan. HELOC operates just like a Personal Line Of Credit or a Credit Card but is secured against your house. You can pay down and withdraw the money as needed, up to the credit limit. The interest rate of this form of second mortgage moves in the same direction as the lender’s prime rate. A HELOC is a flexible second mortgage option because it allows you to control your loan amount, balance, and interest rates.
However, it carries the risk of a credit freeze if you don’t comply with the loan agreement terms, which can be unexpected and when you most need the money.
Private mortgages are short-term alternative mortgage solutions for borrowers who cannot qualify with mainstream mortgage lenders like banks, credit unions, and other monoline mortgage lenders, probably due to their credit or income. A private mortgage lender can be a family member, a friend, or an investment company.
Just like a mortgage from your bank, a private mortgage is registered against the collateral of your house, meaning your home can be repossessed if you fail to satisfy the obligations of the mortgage agreement.
A private mortgage is not necessarily a second mortgage. It can still be your first, third, and fourth mortgage. First, second, third, fourth, and so on are these mortgages’ lien positions on your property.
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There are numerous reasons to obtain a second mortgage, including the desire to pay off high-interest debts or convert the equity in your home into cash to diversify your investments, finance home improvements, or pay off medical bills.
Second mortgages have lower interest rates than credit cards and most unsecured debts. You may choose to get a second mortgage to consolidate these high-interest debts, thus, lowering your overall debt obligations.
A second mortgage loan, too, can be used as a step to a better mortgage at a lower rate. This is a viable path for homeowners with bad credit. Consolidating your debt reduces the number of debts you have. The fewer debts you have should help improve your credit score, allowing you to access more mortgage options with favourable rates.
HELOC is a cheaper line of credit option that a second mortgage loan can allow you to get. The interest rate on HELOC can be as low as Prime plus 0.5. HELOCs are drawable security, making them cheaper for long-term use.
Also, a second mortgage allows you to cash out the equity in your property. You can use this money to finance capital-intensive projects like home renovations, buy a new property, pay medical bills and even invest in other asset classes.
Second mortgage options exist for individuals with low credit scores or poor credit history. Poor credit scores for mortgages are scores below 600. Those with poor credit history for mortgages have had or are currently in bankruptcy, a consumer proposal, collections, or a judgment.
Also, overdue payments and excessive credit hits are all indicators of bad credit for mortgages.
If you consider a second mortgage with bad credit, contact a mortgage broker that deals in Alternative Mortgage Solutions.
Alternative mortgages, commonly called “bad credit mortgages,” are home loans designed for borrowers with poor credit. However, expect to pay a high rate and borrowing costs with bad credit.
When you refinance your mortgage, you replace your existing mortgage with a new one.
This is not the case with a second mortgage.
A second mortgage is an additional loan secured against your property. The existing first mortgage does not change or get replaced when you get a second mortgage. Also, a second mortgage requires that a mortgage be paid out and discharged unless you are refinancing an existing second mortgage.
You can replace both your first and second mortgages by refinancing them.
A second mortgage can be an incredible option for those who can manage the risk that it comes with. This mortgage type is a great option to access the equity in your house for capital-intensive projects like buying a rental property, renovating your home, or investing in a family member.
You can also use it to get ahead of your credit and financial situations by simply consolidating your high-interest debts.
But it is vital that you fully understand the ins and outs of this mortgage type. It comes with a high-risk default. If not managed carefully, your property can be repossessed if you are unable to pay the mortgage as agreed.
The popularity of second mortgage loans has grown, and more lenders have made this loan option stable in their mortgage portfolios. It is essential that you consult with a mortgage expert if you doubt how a second mortgage can help you.