Leveraging the equity in your home is one of the best ways to access large sums of money at manageable rates. According to Mortgage Professionals Canada, 770,000 homeowners took a second mortgage on their homes in 2020, 7.7% of all homeowners in the country. Before taking out a second mortgage, it is worth weighing up the pros and cons to make the best decision for your financial wellbeing.
Wondering what a second mortgage is? Second mortgage can refer to several different products, but it is best known as a lumpsum loan backed by the equity in an already mortgaged property
In the following article, we will provide a complete overview of second mortgages and how they work. Furthermore, we will cover scenarios that explain why a second mortgage can make sense, as well as point you towards the best second mortgage rates in Canada.
What is a second mortgage?
Before jumping into second mortgages, let us take a look at the concept of a mortgage in general. When you take out a mortgage on a home, you are accepting a loan that uses the property as collateral.
When you want to free up equity on a home that is already mortgaged, you can take out another loan known as a second mortgage. As the name suggests, it is a secondary loan on top of the primary mortgage used to buy the property. Just like with the standard mortgage, a second mortgage lender has the legal right to seize your home if you default on the loan.
Homeowners apply for a second mortgage for varied reasons, including debt consolidation, second property purchase, home renovation and acquiring vehicles. While a second mortgage in the strictest sense is a lump sum loan from a lender, some other definitions are sometimes used:
|Types of second mortgages||Definition|
|Home equity loan||The traditional second mortgage, and the focus of this article, allows you to borrow a single lump sum against the equity in your home. In exchange, you put a second mortgage on that property.|
|HELOC||Home equity lines of credit (HELOCs) are sometimes classified as a second mortgage. HELOCs allow you to draw credit when needed.|
|Piggyback mortgage||Some customers opt to take a second mortgage to split the purchase cost of a home across two loans.|
|A second home mortgage||An unrelated loan on a second property|
How does a second mortgage work?
At its most basic, a second mortgage is a lump sum of up to 80% of the value of a property. This is secured against your home and means paying off two mortgages with regular installment payments.
Understanding second mortgages means exploring the fundamentals of home equity. This is what determines how much money you can liquidate from your property when you take a second mortgage on your home.
When you take out a first mortgage, each repayment changes the loan balance, with the amount you have paid off becoming equity. While it may seem complex, calculating your home equity is a simple process. Subtract how much you have already paid towards the loan from the total amount you borrowed.
For example, you took out a mortgage of $300,000 to purchase your home, and you have paid off $120,000 including the down payment. So, you have $120,000 in equity that you can borrow against for a second mortgage.
Equity can also change negatively or positively depending on the value of your home.
What are the Pros and Cons of a second mortgage?
While it may seem instantly tempting to take out a second mortgage and claim a lump sum of equity, it may or may not be the best financial decision for you. Below are some of the advantages and disadvantages to consider before taking out a second mortgage:
- Large borrowing amount
- Relatively low interest rates
- Risk of losing home
- High fees
- Higher interest rates than first mortgage
Pros of a second mortgage
- Borrowing Amount: Because you are securing the loan against your home, you can typically get a larger sum than more traditional loan options. Your property is worth a lot of money and depending on your lender and other factors, you may be able to borrow up to 80% of its value.
- Interest Rates: Second mortgage rates are often lower than other types of loans. Because your home is used as collateral, lenders are more confident (they can seize your home if you do not pay) and will offer favourable interest rates compared to personal loans or credit cards.
Cons of a second mortgage
- Risk of Foreclosure: There is no doubt that when you take out a second mortgage you are assuming risk. You are putting your property on the line, a home you have already gone a long way towards paying off. If you do not maintain timely payments of the mortgage, the lender could foreclose on your home. This is why using a second mortgage affordability calculator is useful before you make a commitment.
- Costs: It is not cheap to take out a second mortgage loan. By time you cover all the associated fees and credit checks, you will be facing a bill of thousands of dollars. Some lenders promise a “no closing cost” benefit on their loans, but even so the costs can add up.
- Interest Costs: Sure, compared to other borrowing options, you can get lower second mortgage rates. Canada has a strong housing sector and companies do compete by offering low rates. Even so, you will still be paying a higher interest rate than your first mortgage.
How can I get a second mortgage?
There is no specific set of requirements that guarantee approval for a second mortgage because lenders have different criteria. However, lenders will look at the following conditions to see if qualify for a second mortgage:
- The value of the property
- The equity in the property
- Your credit score
- Your income
If you are looking for a second mortgage use the tool at the top of this article to get a free quote.
How much can I borrow on a second mortgage?
In most cases, the maximum amount of equity you can borrow is 80%, leaving 20% left on your property. For example:
|Value of home||Amount paid off||Borrow up to:|
So, if your home is worth $300,000 and you have paid $100,000 of your first mortgage, you could qualify to get $80,000 on a second mortgage. This is 80% of the equity ($100,000) available from the first loan. While 80% is a common number, some lenders may offer more or less depending on your specific circumstances.
A lender is unlikely to allow you to leverage all of your available equity. How much you can borrow from your available equity depends on how much you have paid back, your home value and your first mortgage balance remainder.
What are those deciding factors?
- Credit score: Lenders access information from credit reporting agencies to determine your borrowing history. They will require a minimum score of 620 or higher. Your score will also play a significant role in the interest rate.
- Income verification: To determine your ability to repay your loan, the lander will request proof of income including several months of paystubs and your last bank statements.
- Equity: How much of your original mortgage loan has been paid off. This will determine how much you can borrow for a second mortgage.
- Property value: The lender will check that the home you are borrowing against is worth what you say it is. This may include independent value appraisals.
What is the interest rate on a second mortgage?
Our team has seen second mortgage rates as low as 3.99% for well-qualified borrowers, but nailing down a single interest rate depends on the lenders themselves and your income, equity, credit score and property value.
In almost all cases, an applicant will get higher second mortgage rates if they have a low credit score. You can also expect to have a higher interest rate for a second mortgage than your first mortgage.
Canadian lenders offer interest on second mortgages at either fixed or variable rates. Even though the rate will be higher than a first mortgage, it compares favourably to other borrowing methods, such as unsecured loans and credit cards.
How hard is it to get a second mortgage?
Qualifying for a second mortgage is relatively easy if you meet the requirements of lenders. However, lenders will stick to their requirements strictly because they have less of a claim on your home than the primary lender if you do not keep up with payments. Even so, data shows that millions of Canadians have taken out a second mortgage.
Why take out a second mortgage?
Borrowing against the equity of your home is one of the easiest ways to get a large loan. In most cases, you can borrow more than you could with a regular personal loan or credit card, and with better interest rates. Common reasons for taking out a second mortgage include:
- Consolidation of debts
- Medical bills
- Vehicle purchase
- Higher education expenses
- Home improvements
A second mortgage loan can be used towards almost anything. Once the lender agrees to give you the money, it is yours to spend how you wish.
How to get approved for a second mortgage?
As always, shopping around online is a great way to find and lock in the best interest rates. You can compare rates on second mortgages across the top lenders in the country. Moreover, you can search for second mortgage loans that fit your specific demands and information. There are also bad credit second mortgage lenders and comparing online helps you to find these specialists and get the best possible deal. The tool at the top of this page will
You also need to make sure you meet all the requirements a lender will ask for. That means having a suitable credit score, regular income, an accurate valuation on your home, and equity in the property to borrow from.
How long does it take to get a second mortgage?
You probably remember the headaches and days of frustration when looking for your first mortgage and dread the idea of going through all that again. The good news is second mortgages are usually much easier to get. It is usually a smoother application process to receive a second mortgage. Some lenders have commitments to give you funds within days, but it is more common for it to take around a month.
Refinancing vs a second mortgage
Refinancing is when you change the terms of the original loan by changing the length of the repayments, the amount of the loan, potentially the lender and take a new interest rate. Below we will look at the pros and cons of the refinance vs second mortgage debate:
- Change the terms of your current loan: Avoid taking out a second mortgage loan by refinancing your existing loan.
- Single payment: Do not worry about two separate mortgage payments each month.
- Better rates: Get a lower interest rate than you are currently paying.
- You can refinance 100% of your equity: Some lenders allow customers to refinance 100% of their equity.
- Closing costs: You are on the hook for all the closing costs when you decide to refinance, which can total thousands of dollars.
- Interest rate lottery: While you may get a better interest rate, the lender will give you a rate based on the current market. So, you may have a worse rate depending on current trends.
For more information see our complete guide to refinancing mortgages.
HELOC vs a second mortgage
A home equity line of credit (HELOC) is a popular alternative to a second mortgage. Some lenders may use HELOCs and second mortgages interchangeably, but a HELOC is a separate borrowing method. It still works by using your home as collateral, but you get a line of credit that you can tap into when you need it rather than a lumpsum loan.
- No fee cash withdrawals: Most lenders do not charge customers to withdraw from their HELOC.
- No closing costs: Avoid paying closing costs, including no application fees.
- Flexible rates: Move from an adjustable interest rate to a fixed-rate to lock in your rate.
- Repayment flexibility: You can usually pay off a HELOC when you choose, including early with no fees.
- Low-payment trap: HELOCs have low monthly payment commitments that are helpful when times are tough. However, it is easy to get used to paying a low amount each month and the loan never going away.
- Interest rate gamble: Most HELOC loans are on adjustable interest rates, which means you are at the mercy of market trends.
- Home value woes: If you property loses value, you may lose equity you have tied up in the HELOC.
How can I get a second mortgage with bad credit?
While it is harder to find a second mortgage lender with a bad credit score – and you will pay higher interest rates – there are options available. Some lenders cater to low credit customers. Not all homeowners have bad credit because of missed payments, and some lenders are willing to work with people towards a second mortgage.
You will need to make some compromises, including higher interest rates, less equity, and potentially higher fees. To find the best bad credit second mortgage lenders, compare rates and options online. By shopping and comparing rates, you can find the hottest deals that suit your demands.
What happens to a second mortgage in foreclosure?
When you take out a second mortgage, you are borrowing the money against the equity in your home. Essentially, your property is at risk if you miss payments. If the situation escalates, your home could be put into foreclosure. This means the lender will seek to sell your property to recoup what you owe.
Foreclosure is almost a certainty if you default on a first mortgage. Second mortgages are slightly different as the lender may or may not foreclose. This depends on how much you have paid back. The more equity in the property, the more chance the lender will seek a foreclosure.
So, you get a complicated situation where the first lender forecloses. If the second mortgage lender does not recoup their money from the first lender’s foreclosure, they may take legal action to get their investment back.
The important thing to remember is, if you are falling behind with payments, contact your lender. They will be able to help you by offering advice, giving time to catch up on payments or renegotiating your terms. Lenders do not want the hassle of foreclosures and would rather work with customers to find the best solutions.