8 Things You Must Know About Second Mortgages in Canada

If you're a Canadian homeowner, you've probably heard of a second mortgage. So what's the second mortgage? It's a form of loan backed by your house, similar to the first mortgage issued by a conventional bank. Over time, you build up your house's equity, and a second mortgage helps you to use the equity you've built up.

Business Insider estimates that there are more than "1.91 million Canadians with HELOCs, and even more with a second mortgage." HELOC, or home equity line of credit, is a form of the second mortgage since you're essentially adding a second loan to your existing loan to access equity.

There are different types of Second Mortgages.

What's the second mortgage, exactly? These loan products come in a variety of different types. For example, a revolving HELOC gives borrowers continuous access to equity while they pay off what they owe (principle) previously, just like how a credit card operates.

second mortgage in canada

This form of loan may also be a closed second mortgage, which means that you get a lump sum of cash from your equity and pay it off gradually, just like a car loan.

Usually, HELOCs are only offered to those in metropolitan areas with a good credit record. If you have a credit challenge or a small income, private mortgages are possibly your only choice.

Second Mortgages are used for two reasons.

The most common use of a second mortgage is to pay off high-interest consumer loans or to use funds for home repairs or improvements. With an average credit card interest rate of 15%, you could save a lot of money by leveraging a second mortgage.

For example, if you have a credit card balance of $30,000, your monthly minimum payment would be around $600 a month (assuming a 3 per cent minimum payment requirement). If your credit card interest rate is 15 per cent APR, it will cost you around $4,500 in interest in the first year, before you can hit the principal amount you owe.

Too many people are adding a second mortgage, paying off the credit card, and then enjoying a much lower interest rate since the second mortgage is backed by the asset: your house.

The house is used as collateral.

When you take out a second mortgage, you use your house as collateral to the lender. This means that if you don't pay, the bank has the option of foreclosing the first mortgage. That said, since you have a physical asset to back up your debt, your interest rate would be slightly lower.

Interest-only payments.

For certain second mortgage goods, you can opt to make interest payments only. This enables lower monthly payments and helps you to have affordable access to equity in your home until you're ready to sell.

Consider someone who needs to remodel before selling their house or re-negotiating their primary mortgage. They will take the second mortgage, use the funds to renovate, make interest-only payments. When the time comes to sell or renovate, the house is valued at a higher price as a result of renovations, and the homeowner pays off the second mortgage.

You can avoid PMI.

If you qualify for a traditional mortgage, if you do not have 20% to use as a down payment, you would be forced to purchase a private mortgage insurance policy (PMI). This is what we normally call the Canadian Mortgage and Housing Corporation (CMHC) payments in Canada. And they could be very high!

You'll pay 4 per cent of CMHC fees on a $500,000 mortgage loan with 5 per cent down. That's a total of 19,000 dollars!

Taking out a second mortgage in canada along with the first mortgage is one way for borrowers to stop PMI. A second mortgage may add a monthly payment to your budget, but it may be a cheaper choice than a PMI.

Equity can be used for everything.

One of the most appealing advantages of owning a home is the opportunity to use the equity that you have built up over time. Why do you let it sit there? Let the money you received start working for you!

You may use the funds as much as you want, however many people want to use a second home improvement mortgage, other savings, a child's college education, an emergency fund, and more.

One of the most common uses of a second mortgage is to make an investment, including buying a rental property. Instead of saving up to 20% for a down payment, you can tap into the equity of your current home. The bonus of having a second mortgage for investment purposes is that much of the interest on the loan is now available.

The amount you can borrow.

That depends on how much of the equity you have built up in your land. Generally speaking, you're only going to be able to cash out a fraction of the equity that you built up. Lenders have a credit-to-value (LTV) ratio limit and take into account second mortgages.

For example, most second mortgages allow you to access up to 80% of the equity you accrued in your home (85 per cent in major cities). If you buy a property priced at $500,000 and your first mortgage is $325,000, you will be able to access up to $75,000 when you get a second mortgage if you've been allowed to borrow 80 per cent of your home's market value.

Debt Consolidation

If you have huge balances on your credit cards or an immense amount of student loans to pay back, a second mortgage allows you a way to turn all those big monthly payments into one manageable payment that can be easier to handle vs. multiple payments with varying due dates.

You can get a much cheaper rate on a second mortgage than your credit cards, so you can save money in the long run and simplify your monthly loan payments, but even if the rate is the same or higher, you can save on cash flow by reducing your monthly payments. Many credit cards need up to 3% of the outstanding balance.