Second Mortgages & Why Homeowners May Need One
September 28, 2018 | Posted by: Christopher Chanakos
As homeowners in Canada, we are often faced with mounting living expenses and unexpected financial obligations. It could be college tuition, renovation costs, emergency repair bills, debt consolidation, medical expenses or even paying for a wedding. Whatever it is, for a number of reasons, we were not prepared.
So, what are your options? You may contemplate getting another credit card, but you are limited out on your current card and another card with a 19% interest rate is daunting.
However, as a homeowner currently paying for a primary mortgage, you could have an a more attractive option. This is where a second mortgage comes in.
What are second mortgages?
In simple terms, second mortgages are loans that are secured by your home equity. Usually, you can acquire up to 80 percent of your home equity through a second mortgage and if you’re in a major city, up to a maximum of 85 percent.
In contrast to the primary mortgage, a second mortgage has its own terms and conditions. Therefore, the second mortgage is paid separately with a different rate than your first mortgage. In the event of default, the second mortgage will only be repaid after the primary mortgage has been sorted out.
So, when does a second mortgage make sense?
A recent report released by Statistics Canada shows that for every dollar of disposable income, Canadians owe $1.70 in credit market debt. In the 80s that number was 66 cents. In fact, Statistics Canada estimates that the accumulated consumer credit is $630 billion; not including mortgages.If you’re an average working Canadian, it is very likely that you have consumer debt.
Even though the interest rate of a second mortgage is higher than the primary mortgage, it is lower than the accrued interest on credit cards and personal loans. A minimum payment of a second mortgage can be much lower than that of a credit, allowing the borrower to pay off debt faster and keep more money in their pocket.
According to the Huffington Post, the average Canadian credit score is around 600 points. If you’re a Canadian, anything below 650 points is considered a bad credit score and you will probably find it challenging to obtain new credit.
Regardless of the reason for the low credit score, lenders will shy away from approving borrowers for new loans. Even if you are approved, your interest rate would be very high due to the risk.
However, you can get a second mortgage even with a poor credit score. The lender will often overlook the poor credit score if you consistently make your primary mortgage payments and you have a lot of home equity, albeit the interest rate will be higher due to the risk involved. That being said, the interest rate will still be significantly lower than the options mentioned above.
If you can pay off bad credit loans and defaulted debts by leveraging a second mortgage, you can start to repair your credit.
Since the new mortgage rules have kicked in, it is estimated that the rejection rate has increased by 20 percent. Even those who were approved for a mortgage before 2018 can have their mortgage renewal or refinance request turned down due to the stress test.
So, what should you do if you’ve been turned down by traditional lenders? One option is to apply for second mortgages offered via a private lender. Unlike traditional banks, private lenders don’t have their hands tied by the new OSFI rules.
- Sometimes the unexpected happens and we need access to funds quite quickly. Maybe you are starting your own business, got injured at work or have a dependent in a bind.
You could go for an unsecured loan, but you don’t want to end up paying high-interest rates. Payday loans are even worse as the fees and interest rates are exaggerated. Even if you did get a payday loan, the credit limit is $1500, and you probably need more than that.
What about RRSP withdrawal? In this scenario you would get penalized for making that early withdrawal. For instance, if you withdrew $30,000, you would only receive $21,000 after the bank remitted $9000, or 30 percent, to the government.
On the other hand, a second mortgage would give you access to your home equity without the high interest rates charged on credit cards, payday loans or the tax hit you would receive by withdrawing from your RRSPs, especially if the amortization is short-term.
Consult a professional to find a convenient second mortgage
As much as applying for a second mortgage seems like a straightforward process, it is always a good idea to consult a mortgage professional as they have access to a multitude of options/lenders.
Every mortgage is different, and there are always details in the contracts that you need to understand clearly.