In this difficult time of rapidly developing capitalism and the growing number of various offers related to mortgages, many Canadians are thinking about a second mortgage.
The housing market is either heading to a crush or it’s on an all-time-low, depending on your favorite expert. Uncertainty turns people to rushing with the decisions, and with loans — it’s always a fast lane to a financial catastrophe.
Here’s a guide on all the basics: what is a second mortgage, when you can get it safely, how can you do it, and finally —why you may want to avoid it.
What is a Second Mortgage
Ironically, the term does NOT mean a literal “second mortgage”. It’s not just a mortgage that you take when you’ve closed the first mortgage (and before you think about a third one).
When you get your second mortgage, you essentially borrow funds from the capital you have already accumulated in your home. This refers to the difference between the price of the house and the unpaid balance on the first mortgage — in the form of a loan or a credit line.
The second mortgage uses your house as collateral and another loan that you took out for the first time to buy your house. A few things to highlight here to avoid misunderstandings:
- Firstly, a second mortgage makes it possible to use the real value of your home for other projects and purposes that are important to you without having to sell it;
- Secondly, your home may well be an asset that can acquire great value in the future. This method is called a loan for the purchase of residential space;
- There is also another possibility – to take a credit line to purchase housing (HELOS).
How Does the Second Mortgage Work?
Let’s turn to a real-life example: When you buy a house or any other real estate, you apply for a loan to buy a house in a credit institution, which uses the property as collateral. This loan is called the first mortgage.
The cost of the house increases as the borrower pays the loan. The difference between the remaining payments and the house’s value is called the house’s equity.
The mortgage owner can get another loan secured by his capital to finance his needs. So the second mortgage is a loan secured by equity, which the credit institution will charge the borrower.
You must pay both the first and second mortgages on time at a constant or non-constant rate. In this case, it all depends on the loan agreement.
The second mortgage is a rather risky decision because the mortgage that the borrower took at the beginning is more important than the second. In case of bankruptcy, it should be paid first.
Second Mortgage Forms
Finally — to practice. You can take a second mortgage in two main forms — each with its own differences:
- One-time loan: A regular second mortgage is a one-time payment secured by the equity of your home, which provides a lump sum of money that you can spend on your needs. With this type of loan, you will gradually repay the loan, often in fixed monthly installments;
- Credit line: You also have the opportunity to get a loan using a credit line. That is, you have some amount from which you can take. If you are going to get a credit line, you may never need this money, and you do not need to take it, but you have the opportunity to do it if you want. You have a maximum borrowing limit, and until you reach the maximum limit, you can borrow several times. Just like with a credit card, you have the opportunity to take the money and repay debts repeatedly.
Regardless of the type, you can get a loan with a fixed interest rate, which can help you conveniently plan your payments for years. Loans with variable interest rates are mostly reserved for credit lines.
Minimal Credit Score and other Conditions for a Second Mortgage
To get a second mortgage, your credit rating must be equal to or above 620; in addition, you must have a significant net worth. The equity of your house should be large enough to pay off the second loan and keep at last 20% of the equity of your house in the first mortgage.
Second Mortage Benefits
The advantages of a second mortgage include:
- A large amount of credit;
- It will allow you to borrow more significant amounts than you would have taken out if you hadn’t used your house as collateral;
- Access to own capital and the possibility of its competent use. This will allow you to invest money in-home repairs, which will increase its value;
- Thanks to HELOC loans, you have the opportunity to purchase such large purchases as college or major repairs;
- Interest rates on second mortgages can be much lower than on private loans or credit cards.
Second Mortage Disadvantages and Risks
Regardless of what is a second mortgage in your situation is (whether you get it for a new house or a University), all loans should be used wisely. Here are the risks you face:
- The possibility of foreclosure. If, in some cases, you cannot pay the mortgage, then you risk losing your home. Therefore, you should never get a second mortgage to spend it on so-called current expenses;
- A second mortgage can cost you a lot since closing it also costs money. You will have to pay numerous expenses for various things, such as assessments, credit checks, shipping fees, and more. Closing costs can amount to thousands of dollars.
- Loan expenses. Even if you are offered to get a loan without closing costs, you pay anyway; the fact is that you do not see these costs transparently;
- Interest expenses. The rates on second mortgages are usually much lower than the bank’s credit card interest rates, but they are often slightly higher than the rate on your main loan. The second lender takes on much more risk, unlike the lender that provided you with your first loan. If Disadvantagesyou suddenly stops paying, then, in this case, you will not pay the second creditor until the main creditor returns all his money.
Key Points to Understand About a Second Mortgage
Just once again to fight the popular misconception and sum up the thing: here is what a second mortgage really is:
- The second mortgage can be taken out in the form of a loan or a credit line, depending on your own needs;
- The advantages of getting a second mortgage include that you have the opportunity to get a higher loan amount, and at the same time, get lower interest rates, as well as potential tax benefits;
- You can use a second mortgage to finance any of your major purchases, such as paying for college, repairs, a new car, or for example, for a down payment for your second home.
The Bottom Line
If you can get a loan, you can use a second mortgage to pay for repairs, help pay for your child’s college tuition, or, for example, a down payment for a second home. And finally, you can use the second mortgage to pay off other debts that may have higher interest rates.