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?
- What are they used for?
- How do I qualify?
- How much money can I get?
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 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||2.50%||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?
When you apply, you will have a few loan types to choose from depending on your needs. The two most common types are:
Home equity loans
A home equity loan is taken as a lump sum. It can have a fixed or variable rate and repayment will be amortized over five 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 to be approved.
Home equity line of credit (HELOC)
A HELOC has a pre-set borrowing limit that you can use as needed. If you repay any of the amount you take out, then you are free to reborrow it again, just like with a credit card. 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 and more equity than a home equity loan, but it also has lower interest rates. Most HELOCs have a variable or adjustable rate, so your monthly payments will fluctuate with market interest rates.
What’s a piggyback loan?
A third type is called a piggyback loan. It’s different from the others because it’s not used to leverage equity in your home.
Instead, it is negotiated along with the primary mortgage to pay for the purchase of a home. The main reason homebuyers get a piggyback loan is to avoid having to pay mortgage insurance if they don’t have the full 20% down payment. By spreading the purchase over two separate loans, you can avoid the added cost of insurance.
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 reasons:
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 and improving yoru credit score.
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. A second mortgage 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
Getting a second mortgage means you’ve already got a fair bit of equity in your house, and many Canadians 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 for a second mortgage, and they are:
- Equity in your home: The main thing you’ll need to secure a second mortgage is equity in your house. Most lenders want to see about 20%.
- Credit score: Every lender will set their own qualifying credit score before approving a second mortgage, but the higher your score, the lower your interest rate will be. It is still possible to obtain a second mortgage if you have bad credit, but you’ll need more equity in your home, and will probably have a higher interest rate.
- Income: Most lenders will want proof of reliable income before they’ll approve a second mortgage.
- House and property: Primary and second mortgages are secured against the value of the home, so second mortgage lenders will likely want an assessment.
What are the benefits of a second mortgage?
One of the main advantages 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 same reason, they typically have lower interest rates than other types of loans, such as credit cards, personal loans, and regular lines of credit.
Another benefit of a second mortgage is that it can 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 and other penalties.
Are there potential disadvantages?
A second mortgage might sound like the perfect way to achieve your financial goals, but there are some possible downsides to be aware of.
The major one is the possibility of foreclosure: first and second mortgages are both secured against your home, so you have to be able to make payments toward both loans. Unfortunately, the increased debt load can mean a higher chance of defaulting. Before you consider a second mortgage, 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, and this means the second mortgage lender assumes more risk. 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 might incur some fees when securing a second mortgage, including an appraisal fee, a title search, title insurance, and legal fees.
How much money can I get?
The amount you can borrow will depend on a number of factors, including the type of second mortgage product you choose.
With a HELOC, you can borrow anywhere from 65 to 80% of the appraised value of your home.
With a home equity loan, you could access up to 80% of the home’s value, minus the balance of the primary mortgage.
With both of these loans, the amount you’ll actually get approved for will depend on things like the lender, your credit score, your income, and the equity in your home.
For example, let’s say you wanted a second mortgage in the form of a home equity loan. If the appraised value of your home was $300,000, then 80% of that would be $240,000. Now say you still owed $100,000 on your primary mortgage: that would mean you could potentially be eligible for a second mortgage worth $140,000.
Do all lenders have second mortgages?
Second mortgages tend to be riskier than primary mortgages because the lender in the secondary position isn’t necessarily guaranteed to get paid back if the borrower defaults. As such, not all lenders grant second mortgages. That being said, you’ll still have a number of options for second mortgage lenders.
Most traditional lenders have second mortgage products, including most of the major banks in Canada, and many credit unions. These are typically the best options for borrowers with good credit scores who are looking for the lowest interest rates and the best terms.
Even if you can’t find a traditional lender or want to take a different path, 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 a second mortgage if you have bad credit or can’t prove dependable income. Just be warned that the trade-off could be a higher interest rate.
A second mortgage is another type of home loan that many Canadians use to consolidate debts, pay for school, purchase new investments, and achieve other financial goals. There are many advantages to a second mortgage, including getting access to a larger loan amount, and lower interest rates than many other types of loans.
There are plenty of lenders who offer second mortgages, and some will even approve borrowers with bad credit, with less equity in their home, or without reliable income that you can prove.
However, there are potential disadvantages to a second mortgage, and the worst case scenario is losing your home because you weren’t able to afford both mortgage payments. Because of this, it’s important to discuss your situation and options with a financial professional before committing to a second mortgage. If you do choose to move forward with the loan, shop around with different lenders to find the best rates, best terms, and best conditions.
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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.