Knowing When It’s Time for A Second Mortgage
A Guide to Understanding Second Mortgages with the Help of Mortgage Brokers
You’ve probably heard people talk about getting a second mortgage, but might still be unsure of what, exactly, they are and how they work. You’re not alone. While many people have heard of second mortgages, there is still a lot of confusion around what they are and what they’re used for.
A second mortgage is, quite literally, another mortgage that exists alongside your initial mortgage. Unlike your first mortgage, though, a second mortgage is almost always done through private mortgage lenders and private financing. Most banks, credit unions, and mortgage companies offering the best rates and terms simply don’t offer second mortgages, with very few exceptions.
Second mortgages are often seen in a negative light. They are, after all, additional loans against homes, and feature a higher interest rate than a typical first mortgage. Compared to other loans and forms of credit, though, second mortgage interest rates are often much more appealing. That’s part of the reason why they’re such a common option for consolidating debt or making a large investment.
So if you’re looking at a second mortgage to make a large investment, or to give yourself extra breathing room financially, talk to mortgage brokers to see if this is a good option for you. And read on to have a better understanding of second mortgages and when is a good time to consider getting one.
Understanding Second Mortgages
How Does a Second Mortgage Work?
A second mortgage is like your first mortgage. It is a loan that is secured by your home. You will receive a lump sum amount that you will have to pay back. And you have to make monthly payments with a set term and amount to pay off this loan.
If you fail to make payments on this loan, you risk losing your home. What’s more, a second mortgage is generally paid for (and paid off) alongside your first mortgage. They almost always feature higher interest rates than your first mortgage, too.
Is It a Good Idea to Take Out a Second Mortgage?
Ideally, you should only take out a second mortgage under the right circumstances, such as the market value of your home increasing significantly since you took out your first mortgage alongside lower interest rates. You’ll almost never get a second mortgage if your home’s value has decreased, though, because there simply won’t be enough equity in it to register a second mortgage.
A second mortgage is a big financial step, as was your first mortgage, but depending on your circumstances can be quite beneficial. For instance, if you’re struggling with high credit card debt, consolidating that debt through a second mortgage can greatly streamline and simplify your finances. It’s not a magic solution to such issues but can help.
Meeting with a financial advisor should be high on your list of things to do before you take out a second mortgage. You need to be sure you can afford it, as you don’t want to owe more money if you can’t pay it back on time.
How Does a Second Mortgage Work on a House?
The amount of your second mortgage is based on the amount of equity in your home. Your home equity is usually determined by subtracting the amount you owe on your first mortgage from the market value of your home.
You will need to have your home appraised to determine its market value. Besides the appraisal fees, you should be prepared to pay application costs and legal fees.
Do You Have to Have Good Credit to Take Out a Second Mortgage?
Not necessarily. If you have bad credit, you can apply to take out another mortgage from private mortgage lenders instead of a major bank. You can work with mortgage brokers to do this.
If you have good credit, and over 20% equity in your home, you can take out a Home Equity Line of Credit (HELOC) through your mortgage lender, up to a maximum of 80% of the value of your home minus your first mortgage.
Is a Second Mortgage the Same as Refinancing?
A second (or even third) mortgage is a type of mortgage refinancing, but it is not the same thing. Homeowners don’t have to take out another mortgage when refinancing. Instead, they may choose to refinance to get a better mortgage rate and not touch their home equity.
Reasons for Getting Another Mortgage
There are several common reasons for getting another mortgage. Homeowners often take out these additional mortgages to:
Avoid Mortgage Penalties
Some homeowners will get another mortgage if they are behind on their first mortgage payments and at risk of incurring costly penalties. A second mortgage can give them the extra breathing room they need to afford monthly payments and avoid penalties.
Consolidate Debt
Since these mortgages tend to have lower interest rates than signature loans, it makes sense for some to consolidate their high-interest debt. Instead of paying high interest every month for however long it takes to pay off the debt, you can consolidate this debt and only have to make monthly mortgage payments with lower interest.
Boost Business or Renovate a Home
Small business owners may use a second mortgage to give their business the financial boost it needs to grow. Homeowners may also use these mortgages to renovate their homes and increase their home values. This is a great investment if you plan to sell your home one day.
Pay for a Child’s Post-Secondary Education
Some parents prefer to take out second mortgages to pay for their kids’ educations instead of having their kids go into debt with student loans, making this a great investment for their kids’ futures.
Second Mortgages as An Alternative to Refinancing
If you’re considering a second mortgage because you’re having difficulties paying your first mortgage, consider mortgage refinancing to lower your monthly mortgage payments. You may be able to find lower interest rates when refinancing and you don’t have to touch the equity in your home.
But if refinancing isn’t an option, a second mortgage usually has lower interest rates than other loans.
Qualifying for A Second Mortgage
When applying for a second mortgage, lenders will look at the following factors to see if you qualify:
- Equity—The higher your home equity amount, the higher the likelihood you’ll qualify for a second mortgage.
- Ability to Make Payments—Because most second mortgages are done through private lenders, stable income isn’t usually a factor. These lenders are more concerned with how you will make payments and get their money back.
- Credit Score—The higher your credit score, the lower your interest rates will be. You’ll also qualify for mortgages from more lenders with a good credit score. But as mentioned before, you may still qualify for a second mortgage from a private lender if you have a bad credit score.
- Property—if any of the above factors seem risky to lenders, such as a poor credit score, they will need to secure their investment in your property. if you don’t pay them back, they can foreclose your home to recoup the amount owing. But all additional mortgages are registered, on the title, as a mortgage lien—not just if your file is deemed a risk. What’s more, a second mortgage is inherently risky because the first mortgage lender is under absolutely no obligation to tell the second lender if the borrower is in arrears on payment.
Risks and Benefits
The risk of losing your home if you default on your payments is a huge risk that may not be worth taking for some. But if you plan for these additional mortgage payments and are financially responsible, this isn’t a big risk.
This risk lies with homeowners who use a second or third mortgage to consolidate high-interest debt and find themselves in more debt—e.g. maxing out the credit card again—soon after.
So if you’re in a situation where you will likely rack up more high-interest debt in a short time after consolidating your debt, then you should address the problems that are causing this debt before taking out a second mortgage.
But if you are able to pay off your second mortgage without incurring high-interest debt elsewhere, this loan can help you invest in your future. Along with paying off high-interest debts, you can use this loan to pay for your child’s education or upgrade your home to increase its value.
Working with Private Lenders vs. Banks
If you qualify, you can get a HELOC through your mortgage broker with a lender such as a bank. A HELOC offers a lower interest rate, but most HELOC lenders require you have at least 20% equity in your home. Most banks will only offer up to 80% of your home’s value in a loan, with only 65% available through a HELOC. The other 15% would have to come from a mortgage.
Most private lenders require you to have at least 10% equity in your home; most second mortgage lenders won’t offer more than 85 or 90% financing. This means that, if your first mortgage provides up to 80%, a private lender could give a second mortgage for 5% or 10% of your home’s market value.
If you can benefit from a second mortgage and can budget for it, get in touch with a mortgage broker to discuss your options. Mortgage brokers can help you find second mortgage loans from private lenders so you can start investing in your future.
Chris Allard’s experience in the field means he can get you offers with over 50 financial institutions lending in Ottawa. Every lender has many mortgage products they offer, which means Chris and his team will make sure a mortgage caters to your needs while also ensuring you get a competitive rate. Chris Allard is a proud mortgage broker of Smart Debt Mortgages, independently owned and operated. Smart Debt broker #12236.