The mortgage world has a language of its own, and if you’re a homeowner in Canada with financial goals like consolidating debt, then the term second mortgage might be one you’ve heard tossed around.
More than 3 million Canadians have a home equity line of credit (HELOC), which is one type of second mortgage, and they owe an average of $65,000 each.
There are many reasons why people choose to get one, including to free up and use your money elsewhere. Not sure about how they work or if one is right for you? In this guide we’ll cover:
- What is it?
- What rate will I get?
- What types exist?
- How much money can I get?
- What are they used for?
- How do I qualify?
What is a second mortgage?
A second mortgage is an additional home loan you take out while the original mortgage is still in place that lets you access the equity you have built up in your home and use it for other projects or financial purposes such as debt consolidation. It is possible to access up to 80% of your home’s appraised value, minus the unpaid balance of the existing mortgage.
They may be negotiated with the original mortgage issuer or another lender such as major bank, trust company or private mortgage lender at fixed or variable rates varying from 2.5% to 15%.
You have to make payments on both loans at the same time and your home functions as collateral for the new loan so both lenders have the option to foreclose if you do not pay. In this case, the original mortgage lender gets higher priority which is why rates for second mortgages are higher.
What is home equity?
Home equity is the difference between the current market value of your home and the outstanding balance remaining on your mortgage. It is increased as you pay down your mortgage by the portion of your payment that goes toward the principal and as the value of your home increases.
For example, if your home is appraised to be worth $500,000 and you owe $300,000 on your mortgage, your home equity would be $500,000 – $300,000 = $200,000.
What rate will I get?
|Lender||Example company||Product||Interest rate||Credit score||Minimum equity|
|Major bank||Royal Bank of Canada||Home equity line of credit||3.00%||650-900||25%|
|Trust company||Equitable Trust||Mortgage (in second position)||15.00%||550-700||10-15%|
|Private mortgage lender||Tridac Mortgage Corporation||Mortgage (in second position)||10.00%||Less than 600||10% or less|
What kinds of second mortgages are there?
The two most common types are:
Home equity loans
A home equity loan is taken as a one-time lump sum. It can have a fixed or variable rate and repayments towards interest and principal are made in fixed amounts on a fixed schedule amortized over 5 to 15 years. Most lenders allow you to do what you want with the money, but some will only approve it if the money is for home renovations or improvements.
They typically have higher interest rates than a home equity line of credit (HELOC), but you don’t always need as high a credit score or equity in your home to be approved.
Home equity line of credit (HELOC)
A HELOC is revolving credit secured by the equity you have in your home as collateral. You can borrow money from it whenever you want to use as you see fit, pay it back and borrow it again up to a pre-set limit, just like with a credit card. There is no fixed repayment schedule and lenders will typically only require you to make a minimum payment of the interest owed each month. Interest is only charged on the amount you take out – not the total amount of credit available to you. The repayment terms are open, so you can repay in full at any time.
There’s usually a set draw period on a HELOC – often around 10 years – during which you can take out money at your leisure and make interest-only payments. That is then followed by a repayment period for the principal and interest, which can range from 10 to 20 years.
A HELOC is harder to qualify for and typically requires a higher credit score than a home equity loan and at least 20% equity, but it has lower interest rates. Most HELOCs have a variable or adjustable rate, so your monthly payments will fluctuate with market rates.
What’s a piggyback loan?
A piggyback loan is a third type of second mortgage that is used to when the buyer does not have the 20% or more for the down payment to avoid having to pay Canadian Mortgage and Housing Corporation (CMHC) mortgage insurance. By taking out a separate loan to supplement the down payment to ensure it reaches the 20% minimum, you can avoid the added cost of insurance which on a $500,000 mortgage with only 5% down would be $19,000 (4% CMHC fees) and save you money overall. It is negotiated alongside the primary mortgage to pay for the purchase of a home and is not used to leverage existing equity.
How much money can I get?
The amount you can borrow will depend on a number of factors, including the type you choose, the type of lender, your credit score, your income, and the equity in your home.
HELOC example calculation
With a HELOC, you can borrow up to the lesser of:
- 65% of the value of your home (comes into play if home is almost or completely paid off)
- 80% of the appraised value of your home minus the outstanding balance on your mortgage
For example, if the appraised value of your home was $500,000, the absolute maximum HELOC limit based on the maximum allowed loan-to-value (LTV) ratio of 65% would be $325,000.
Now say you still owed $300,000 on your primary mortgage (equity of $200,000). Based on this and the maximum allowed loan-to-value (LTV) ratio of 80%, the other limit would be $100,000, which would mean you could qualify for a HELOC with a limit up to $100,000 as it is the lesser of the two.
|Appraised home value||$500,000|
|Maximum loan-to-value (LTV) ratio||x 65%|
|1. Maximum loan allowed||= $325,000|
|Appraised home value||$500,000|
|Maximum loan-to-value (LTV) ratio||x 80%|
|Outstanding mortgage||– $300,000|
|2. Maximum loan allowed||= $100,000|
|You take out||$50,000|
|Interest-only monthly payment||$125|
Home equity loan example calculation
With a home equity loan, you can access up to 80% of the home’s value, minus the balance of the primary mortgage.
For example, if the appraised value of your home was $500,000, then 80% of that would be $400,000. Now say you still owed $300,000 on your primary mortgage: that would mean you could potentially be eligible for a second mortgage worth $100,000.
|Example: Home equity loan|
|Appraised home value||$500,000|
|Maximum loan allowed||x 80%|
|Loan amount||= $400,000|
|Less outstanding primary mortgage balance||– $300,000|
|Loan limit||= $100,000|
What are second mortgages used for?
There are many reasons people take out second mortgages on their homes. It all comes down to accessing equity to achieve other personal or financial goals. Here are some of the most common uses:
Debt is a major problem for many in Canada. In fact, nearly 70% of Canadians live with debt obligations, and 84% of people in the country say their top financial priority is getting out of debt. If that sounds familiar, then you might be able to use a second mortgage to bundle your debt together and negotiate a lower interest rate, and that means paying off your debts faster, improving your credit score and enabling you to qualify for a prime lender sooner.
Many Canadians have multiple sources of high interest debt they could consolidate, such as:
- Student loans
- Credit card balances
- Car loans
- Unpaid bills
Home renovation projects
Home renovations and improvements are an excellent way to make your home more comfortable and increase its value, but these projects cost money. Taking money out of your house is a great way to put value back into your investment.
As many as 53% of Canadians live paycheque to paycheque, and that means many of us don’t have enough money leftover at the end of the month to put into savings or emergency funds. It can be a great way to free up some extra cash that you might need to cover unexpected expenses.
Paying for education
Education is a sound investment, and whether you want to make a career change and go back to school yourself or help out your kids with college or university tuition, it can provide the money to fund your or your child’s future.
Making new investments
You can take that equity and reinvest it elsewhere, such as in a second home or rental property.
How do I qualify for a second mortgage?
There are four major elements a lender will consider when you apply:
- Equity in your home: The more equity you have, the higher your chances of qualifying are. Most lenders want to see about 20%.
- Credit score: Every lender has their own credit score requirements, but the higher your score, the lower your interest rate will be. It is still possible to get one if you have bad credit, but you’ll likely need more equity in your home, and will probably end up with a higher interest rate.
- Income: Lenders will want proof of reliable and consistent income to ensure that you can make payments.
- House and property: Both primary and second mortgages are secured against the value of the home, so one or both lenders may want a home appraisal.
In addition, to qualify for the additional loan through a regulated lender (bank) you will have to pass a “stress test” as you would for a primary mortgage. Non-regulated institutions such as credit unions and other lenders are not required to implement the test, but may do anyway.
What are the benefits of a second mortgage?
The primary benefit is that it can give you access to a significant amount of money. This is because the loan is secured against the value of your home, so it’s less risk to a lender. For this reason, they typically have lower interest rates than other types of loans, such as credit cards, personal loans, and regular lines of credit.
It can also give you access to the equity in your home without having to renegotiate the primary mortgage, and that can save you a lot in prepayment fees and other penalties.
What are the downsides?
The biggest downside is the possibility of foreclosure. First and second mortgages are both secured against your home, which means you have to be able to make payments toward both loans. The increased debt load can mean a higher chance of defaulting, so take a close look at your income and current debts to make sure you can manage the additional payment.
In the case of foreclosure, the primary mortgage lender will be paid first, which means the secondary lender assumes more risk and as such, second mortgages typically have higher interest rates than primary mortgages.
Fees are another thing to consider. Just like with a primary mortgage, you may incur some initial fees to set it up including an appraisal fee, a title search, title insurance, and legal fees.
Do all lenders offer second mortgages?
They are not offered by all lenders. They are riskier than primary mortgages because the lender in the secondary position isn’t necessarily guaranteed to get paid back if the borrower defaults.
That said, they are offered by most traditional lenders including most of the major banks in Canada, and many credit unions. These lenders are typically the best options for borrowers with good credit scores who are looking for the lowest interest rates and the best terms.
Other options include:
- Private/online lenders
- Trust companies such as Home Trust or Equitable Trust
- Mortgage companies
These lenders can sometimes be more flexible with qualification criteria, and that means you might even be able to negotiate if you have bad credit or can’t prove dependable income. The trade-off is usually a higher interest rate.
Many Canadians use second mortgages to consolidate debts, pay for school, purchase new investments, and achieve other financial goals. There are many advantages, including getting a larger amount and lower interest rates than other types of loans.
However, the worst case scenario is losing your home because you weren’t able to afford the payments so it’s important to discuss your situation with a financial professional (that isn’t the lender) before committing. If you do choose to move forward, shop around with different lenders to find the best rates, terms, and conditions.
What to read next
Over to you
Are you a homeowner who secured a second mortgage? We’re interested to know – what did you use the money for, what lender did you choose, and how did you manage the payments on both mortgages? Help other Canadians make their own financial decisions by sharing your experience in the comments below.