With inflation sky-high, you might be considering leveraging the equity in your Victoria BC home to finance an important project or meet a big expense. A second mortgage uses your home as collateral for an additional loan on the property. There are pros and cons to this, which we will discuss below, but first let’s go into the details of what a second mortgage is and how it works.
What is a second mortgage?
A second mortgage allows you to borrow money against the equity in your home, resulting in two mortgages on the same property. This money can be in the form of a lump sum, in which case the mortgage is called a Home Equity Loan, or a line of credit, called HELOC (Home Equity Line of Credit).
One of the prime benefits of a second mortgage is that it allows you to access the equity in your home without breaking the first mortgage, as would be the case if you refinance your mortgage. This is especially advantageous if your first mortgage has a good interest rate or if there would be a penalty to break the mortgage. And let’s face it, in 2023, with interest rates as high as they are, your current mortgage probably has a much better rate than what you could get now.
Borrowing on the equity of your home makes sense in quite a few situations. Sometimes a second mortgage is used strategically, and sometimes the unexpected just happens, and it is nice that there is an option to get the funds to deal with it. The most common reasons Canadians take out a second mortgage include:
- Debt consolidation: Consolidating your higher interest debts such as credit card or student loans under a single second mortgage loan at a lower interest rate..
- Home improvements that increase the value of your home are an effective use of a second mortgage.
- Buying a second home: Canadians sometimes use a second mortgage to pay the down payment on a second property.
- Major Purchases: Second mortgages can be used for anything and Canadians do use them for major purchases such as education or business expenses.
How does a Second Mortgage Work?
A second mortgage allows you to borrow up to 80% of the value of your home, however, you need to subtract your current first mortgage from that, which then leaves the available accessible equity. For example, let’s say your Victoria BC home is worth 1 million dollars, you could borrow up to $800,000 against it, but you’ve got a first mortgage of $400,000 of the mortgage, so that means you could borrow up to $400,000 in a best-case scenario.
Of course, there are other criteria that come into play such as: your credit score (the higher the better – at least 600), the amount of equity in your home, your income and the appraised value of the property. All these factors will determine the interest rate of the loan as well as the type of second mortgage you can obtain. In any case, the rates for second mortgages are generally higher than for first mortgages.
Process of Applying for a Second Mortgage
The process of getting a second mortgage is more or less the same as for a first mortgage: You submit an application to a lender and provide documentation detailing your income, debts and assets. The process is usually quicker and smoother than for a first mortgage.
2nd Mortgage loans for Bad Credit
Getting a second mortgage is still possible even if you have bad credit (Under 600). You may need to pay higher interest rates however or receive a lower percentage on your equity or possibly pay higher fees. A lender will consider the reason for your low credit score; but the good news is that many lenders are willing to work with the borrower’s unique situation these days.
Most Common Types of Second Mortgages
The two common types of second mortgages serve different purposes and have different qualifying requirements. It is easier to qualify for a Home Equity Loan, but the cost is usually more.
- Home Equity Loan is a lump sum secured against your home that you pay back, with interest, over time with a fixed monthly payment. A Home Equity Loan usually comes with a higher interest rate than the HELOC, however unlike the HELOC, you can access more of your equity since you can borrow up to 80% against the value of your home, less any existing first mortgage.
- HELOC or Home Equity Line of Credit works much the same way as a regular line of credit, or a credit card, except it is secured against your home. A HELOC allows you to borrow the amount of money you need, when you need it, up to the credit limit. You are charged interest only on the amount you borrow. The interest rate for the HELOC is typically less than the Home Equity Loan, however you can only borrow up to 65% of your property value, less of course any existing mortgage. In addition lenders are seeking credit scores above 680 to qualify for this type of loan.
Pros and Cons of Second Mortgages
Second mortgages can make good financial sense in some situations, however, they do come with some drawbacks.
Pros
- Higher Borrowing Amount. Because you are securing the loan against your home, you can potentially borrow a larger amount than with traditional loans.
- Lower Interest Rates. Since your home is being used as collateral, the loan is fairly low risk for lenders and they can offer lower rates than a traditional loan.
Cons
- Risk of Foreclosure. If you default on payments, the 2nd lender, like your 1st lender can foreclose on your home.
- Costs and Fees. There are a number of costs associated with getting a second mortgage such as: appraisal costs, credit checks, lender fees etc.
- More Debt and Interest to Pay. While second mortgages offer lower rates than traditional loans, they are usually higher than first mortgages. You will be adding another monthly obligation to your bills, which only makes sense if it’s improving your overall cash flow and or solving an immediate problem.
Final Word on Second Mortgages
In some situations, a second mortgage makes good financial sense. When you use the equity in your home to increase its value through renovations, remodeling or expansion, you are increasing your equity or ownership stake in the property.
Replacing expensive debt, such a credit card debt, with cheaper second mortgage debt is another good reason to consider a second mortgage. Or you may simply need to deal with an unexpected personal, medical and or family emergency.
However, you’d be wise to weigh the benefits of a second mortgage against the risk of losing your home should and if you default. Always remember, using your home as an ATM machine is never a good idea.