Sometimes life throws a curveball your way and you need access to more cash ASAP. Whether it’s an unexpected medical expense, tuition, emergency home repairs or a need to consolidate your debt, there are plenty of ways a second mortgage can help you tap into your home’s value so you can take the equity you’ve built over time and turn it into the money you currently need.
What Is A Second Mortgage?
To put it simply, a second mortgage is an additional loan you take out on a property that is already mortgaged. For lenders, offering 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, rates for second mortgages are always higher than those for primary mortgages.
Types Of Second Mortgages
There are multiple avenues you can pursue if you’re considering a second mortgage and each one has different requirements you’ll need to meet.
Home Equity Line Of Credit (HELOC)
A home equity line of credit is a great option for individuals who have good credit and more than 20% equity in their home as it’ll be the most affordable option in terms of interest rates. With a HELOC, you only pay interest on the amount of equity you use. If you have $50,000 available and you only want to use $25,000, you’ll only get charged interest on the $25,000. HELOCs will give you payment flexibility and lower interest rates but you’ll need to be disciplined to use it as the line of credit could end up costing more over time if you choose to only pay off the interest as required.
Mortgage Cash-Out Refinancing
It’s important to note that a mortgage refinance is not the same as a second mortgage. This option may be a better alternative to a second mortgage, especially when interest rates are low. With a cash-out refinance, you’re basically renegotiating your current mortgage to access the equity in your home. When a lender refinances a mortgage, they’re aware that there’s already a lien on the property which they can take as collateral if you don’t make your payments on time. This isn’t the case with second mortgages, so the risk is lower for lenders to refinance.
Mortgage For Second Property
As COVID-19 continues to drive up demand for vacation rentals and second homes, you may be considering the purchase of a second property and a second mortgage could help. Taking on an additional mortgage for another property is a big financial decision. It’s important to remember that what you’re investing in goes beyond the initial price tag as it will require regular maintenance and upkeep that can add a hefty amount to your bottom line. As with most home purchases, a 20% down payment will be required, unless you or your family members are going to live in this second home rent-free. It’s also worth noting that the Canadian Home Buyers Plan, which allows you to tap into your RRSPs, does not apply to a second property.
Eligibility Requirements For A Second Mortgage
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:
The most basic requirement to access a second mortgage is to have equity built up in your home. As you pay off your principal loan balance over time, the portion of the loan you pay off is called equity. This equity that you build up in your home is very valuable, so the more you have, the higher your chances of qualifying for a second mortgage.
Taking out a loan, and in this case a second one, is always risky. There’s a chance a borrower won’t be able to make payments due to a high debt-to-income ratio so lenders will want to verify that you have sufficient income to make your payments on time once a new loan is added to your pile of bills. Typically, you’ll need a debt-to-income ratio of 43% or lower to qualify. You’ll also need to show proof of income and proof that you’re currently able to make on-time mortgage payments.
As with any loan, the higher your credit score is, the better interest rates you’ll get access to. Typically, you’ll need a credit score of 620 or higher in order to be considered as a candidate for a second mortgage. If you’re interested in pursuing a second mortgage, make it a point to check your credit score in advance so you have a better idea of where you stand in the eyes of potential lenders and if you need to take more time to improve your score before you move forward through the process.
Reasons To Get A Second Mortgage
There are many reasons why you might consider taking out a second mortgage. Tapping into the equity you’ve built up in your home is a great way to access large amounts of cash quickly which can help you take care of other tasks, bills or goals.
Second mortgages have lower interest rates than credit cards do, so if you’ve got debt you need to pay off, the equity from your home can help you get there faster.
Borrowing For Major Purchase
Whether it’s unexpected medical equipment, a new vehicle or urgent home renovations/repairs, a second mortgage can help you manage these major purchases when you don’t have the savings accessible to do so on your own. Options like the home equity line of credit also give you access to revolving credit as long as you make your payments so if you have reoccurring payments to worry about, this could be more manageable for you.
Buying A Second Property
If you’re on the hunt for a cottage, investment property or vacation home, a second mortgage can help make the purchase possible. Keep in mind that you’ll still need to have money for a down payment on the second property and you’ll have to budget for the additional mortgage payments, utility bills and property taxes.
It’s important to understand all the options available to you if you’re considering taking out a second mortgage in Canada. Second mortgages add another payment to your budget and can be a bit more tricky to obtain, so do your homework when it comes to lender requirements and the consequences that come with missed payments. Have more questions? Want to learn more about your options? Get in touch with our experts at Edison Financial.