Very simply, second mortgages are additional loans that are taken out against the same property. Let’s take for instance that your home has an existing mortgage on it, and you take out another loan on your home, the second loan is referred to as the second mortgage to the property.
In real estate, a property can have multiple loans or mortgages against it. A first mortgage can be followed by a second mortgage, then a third mortgage, and so on as necessary, although having more than two loans on the same property is very rare. The date on which the homeowner made the loan determines the order of the priority of the loan. This means that in case you default, your first mortgage has priority and it gets paid off first before any amount is put towards the second mortgage.
Types of Second Mortgages
The two main types of second mortgages are:
- Home equity loans – You get a lump sum loan from a lender all at once, and repay it according to the agreed amount and time period. Interest for this type of loan are usually at fixed rates.
- Home equity lines of credit –This works similar to a credit card, wherein you borrow the money as you need it up to a specified credit limit. Interests are typically set at adjustable rates.
How Much You Can Borrow
The amount that can be borrowed on a second mortgage is based on the equity in the home, which is equivalent to the current market value of the home or property less any remaining mortgage payments. Second mortgages and the subsequent loans on the same property have a higher risk of being paid out, depending on the equity. Hence, they often have a higher interest rate than first mortgages.
Terms for second mortgages are typically from as little as one year to up to 30 years. The shorter the loan term, the higher the monthly payment will be.
How to qualify for a second mortgage
A borrower must have over 20% of equity in the home or property and is able to pay the monthly payments on the second mortgage without exceeding current Total Debt Service Ratio (TDS), which should not be more than 40% of your gross monthly income.
Additional costs of second mortgages
Just as with a first mortgage, you will also need to pay closing costs with a second mortgage. Approximate costs can be from 3% to 6% of the amount of your second mortgage. Some of these additional costs are:
- Home appraisal fee
- Legal fees
- Title search
- Title insurance
In some cases, the steep fees associated with securing a second mortgage may not be worth the actual loan. You will have to calculate carefully the loan amount, loan term and all additional costs involved to see if the principal amount can cover more than enough after interests and additional costs.
Why get a second mortgage
Many Canadians need to get a second mortgage to help achieve other financial goals that require big expenditures. Some ways to put a second mortgage to good use:
- To consolidate multiple debts or a high interest debt into one low interest rate monthly payment.
- Can be used towards home improvements and renovations.
- To purchase additional homes or property
- To finance a small business
- To help pay for college or university education
- As financial aid for emergency expenses
- To avoid paying Private Mortgage Insurance (PMI) on their first mortgage
- To create a home equity line of credit (HELOC)
It’s generally not a good idea to use second mortgages for trivial or inconsequential purposes such as to fund a vacation or to buy new clothes, because you are risking your home in the process.
Advantages of a Second Mortgage
- You can get a large sum of money because the loan is tied to your home’s equity. Up to 90% of home value can be used to arrange a second mortgage.
- Interest rates are usually much lower than other forms of financing, such as using a credit card or getting a personal loan. It would be more financially sensible, for instance, to pay 6% or 7% for a second mortgage as against 20% on a credit card.
- Interest paid on second mortgage loans may be tax deductible.
Where to Get a Second Mortgage
Second mortgages may be obtained from any lender. If you have a first mortgage, you are not obligated to get your second mortgage from the same lender. The best thing is to get several quotes from different lenders so you can compare interest rates and total fees.