If you need money- whether to pay off debts, cover unexpected expenses or even to do home renovations, wouldn’t it make sense to tap into the equity that you’ve built up in your home? There are some situations in which homeowners can leverage that equity by taking out a second mortgage. But before you go down that road, you need to be well informed about the short and long term implications.
“Even though it is still called a mortgage, a second mortgage is very different in a number of ways from the mortgage that you already have on your house. There are potential consequences involving the asset of your home,” says Jeff Schwartz, executive director, Consolidated Credit Counseling Services of Canada.
Here are the requirements, pros and cons of second mortgages.
Second mortgage facts
For lenders, there is a pecking order if you default on your mortgage loan. If your home is sold because you’ve defaulted on the loan, the lender that has given you your first mortgage gets first dibs on the money from the sale. The lender for the second mortgage has to wait and take what (if anything) is left, which is why it is deemed a riskier loan from a lending point of view.
Many “traditional” banks don’t deal in second mortgages for that reason. You are likely looking at dealing with a trust company or alternative lender.
How do I qualify?
People take out second mortgages for a variety of reasons. If you are interested in tapping into your equity, from a cost and interest rate point of view, it may be better to take out a home equity line of credit (HELOC) or to refinance your first mortgage to take out a larger amount. However, that isn’t always possible for some homeowners, which is why some consider a second mortgage.
Much like with your first mortgage, you need to meet the proper lending criteria, like having a low debt-to-income ratio to ensure that you will comfortably be able to make the payments. You also need to have a good credit score and repayment history.
The real distinguishing feature is that in order to qualify for a second mortgage you need to have built up sufficient equity. In theory, you can borrow up to 80 per cent of your home’s appraised (not market) value, minus whatever balance you have on your current mortgage. Your home also needs to meet specific criteria to make sure that it is a valuable asset to secure the loan against.
Second mortgage pros
Rates for second mortgages are often lower than other debts that you might have, like credit cards and car leases, which can make them a more attractive option.
If you’ve had trouble with budgeting, the steady payment of a second mortgage could simplify your life and help you budget appropriately. You receive your second mortgage funds as a budget-friendly lump sum, which can also help you from running your debt back up again. With a HELOC, you are drawing on it as needed and making payments accordingly, which can be challenging from a budget and debt reduction point of view.
Second mortgage cons
“Since second mortgages are typically done through trust companies and alternative lenders and are viewed as a riskier loan, they tend to have much higher interest rates than traditional first mortgages. Although the rates are typically lower than credit cards, you will pay a premium to borrow through a second mortgage. There are often additional fees to take out a second mortgage. You need to do the math to make sure these extra costs make sense,” says Schwartz.
Another downfall of borrowing more against your home is that you are putting your home at risk. If for some reason you can’t make the payments, you could be at risk of losing your home.