A second mortgage allows homeowners to take out a loan and borrow against the equity they’ve built up in their homes by using the home as collateral. Homeowners may want to borrow money for the purpose of consolidating debt, paying off bills, making home renovations and more. The average homeowner in Canada has a loan-to-value ratio of 27%, which means that the average home equity is 73% [Mortgage Professionals Canada]. If you have an existing mortgage, you may qualify for a second mortgage should you find yourself in need of accessing your home equity and acquiring a large amount of cash. Learn more about how second mortgages work to see if they may be a good fit for your personal situation.
Why Are Second Mortgage Rates Different?
For lenders, taking on a second mortgage is risky as they’re in second position on your title. This means if you default on your payments and the property gets taken into possession, the lender in first position with the original mortgage will always get paid out first. Due to this added risk, mortgage rates for second mortgages are always higher than principal mortgages.
Specific requirements for getting approved for a second mortgage will depend entirely on your lender. Be sure to do your homework and understand what’s required of you to qualify and how that may differ by lender. Typically lenders will look at four areas across the board to determine if you’re a good candidate for a second mortgage: equity, income, credit score and property:
- Equity is key. The more you have available, the higher your chances of qualifying for a second mortgage. If you’re purchasing a house, a larger down payment also decreases the risk that a lender takes on.
- Lenders want to verify that you have a dependable source of income to ensure that you can make payments on time.
- Your credit score plays an important role. The higher your score, the lower your interest rates. It’s as simple as that.
- What property you own will definitely come into play. Since looking at other factors like a credit score can make it difficult to properly calculate risk, lenders will look to other sources to secure their investment in case you are unable to keep up with mortgage payments.
Why Do You Need A Second Mortgage?
Second mortgages are typically used to consolidate debt, make home renovations or improvements, pay for tuition, cover the cost of medical expenses or access cash for investment purposes.
While second mortgage rates are typically higher than those you’ll find for primary mortgages, they’re often much lower than rates you’d find with credit cards or lines of credit. For this reason, second mortgages tend to be a wise choice when you find yourself in need of a large chunk of additional money. Take the time to compare rates across the board so you can weigh the pros and cons of all your options before making any final decisions.
What Fees Will You Encounter With A Second Mortgage?
When applying for a second mortgage, it’s important to note that you’ll encounter a variety of different fees, so you’ll want to be prepared to ensure the benefits outweigh the costs upfront should you choose to pursue a second mortgage.
Some common second mortgage fees include:
- Administrative fees: $150 – $200
- Legal fees: $500 – $1500
- Home appraisal fees: $300 – $600
- Title search: $250 – $500
- Private mortgage lender fees: 1% – 3%
Different Types of Second Mortgages
When it comes to applying for a second mortgage, you’ll have a few options to consider, so it’s important that you understand how each one differs so you can choose which is best suited for you.
Home Equity Loan
A home equity loan works like any other type of secured loan, but it uses your house as collateral. As part of this process, your lender will allow you to borrow a specific amount of money that’s based on the value of your home, and you’ll be charged interest and have fixed instalment payments to pay it back. In order to qualify, you need to own a house (which needs to be appraised by your lender), have paid off a significant portion of your mortgage and be financially secure enough to handle taking on more debt.
A home equity line of credit (HELOC) is a revolving line of credit that lets you borrow the equity in your home at a much lower interest rate than a traditional line of credit. You’ll have to pay interest on the money you borrow through a HELOC but you’re able to borrow and repay over and over as you need cash, up to a certain maximum credit limit. The lender uses your home as a guarantee that you’ll pay back money that you borrow. To apply, you must have at least 20% equity built up in your home.
Also considered home equity loans, private mortgages differ in that they’re offered by private lenders and have less strict lending requirements. They’re typically fixed loans with higher interest rates but they’ll allow you to access up to 95% of your home’s value and often don’t require a minimum credit score.
A cash-out-refinance has the same characteristics of a second mortgage with some key differentiating factors. If you choose to refinance your first mortgage, you can borrow up to 80% of your home’s value. The difference between the amount that you are borrowing and your first mortgage amount what you’re borrowing as cash.
A mortgage refinance is the process of getting a new mortgage for your home, whether it’s from your current lender or a new one. You effectively pay off the first loan in full by using the second (new) one which allows you to lock in with a better interest rate and a new loan term. Keep in mind that this process will bring with it fees and penalties (typically around 3 months’ worth of interest) so make sure the lower rate outweighs these upfront fees in the long run.
In order to pursue refinancing, you’ll need to meet some specific requirements regarding how long you’ve owned the home, what your credit score is, your financial history, how much home equity you have built up in the home and your debt-to-income ratio. While the minimum equity requirement varies by lender, you’ll typically need 15% – 20% equity to pursue refinancing.
Depending on your personal situation, taking out a second mortgage to borrow against the equity you’ve built up in your home may be a great fit to help you finance renovations, pay for tuition or even consolidate your debt. Understanding how second mortgages work and what risks you take on by using your home as collateral is an important first step in the decision making process. Want to learn more about home equity and you mortgage options? Reach out to our team and let’s start the conversation.