Anytime you are considering a mortgage or loan where your home is going to be involved, it's important to understand your options. I have talked to many clients who want to know if and/or when to consider a second mortgage. I always tell them it depends.
If you are going to consider a second mortgage, then you want to determine if the second mortgage will put you into a better financial position over the long term. If a second mortgage isn't helping you to move toward your financial goals, then you may want to consider other options.
A second mortgage will have a higher interest rate and fees compared to a first mortgage. Some lenders also offer home equity lines of credit behind existing first mortgages.
A home equity line of credit will have a very good interest rate, typically ranging from prime plus 0.50% to prime plus 1.0%. A second mortgage will have an interest rate that could be 8% or more above the home equity line of credit.
When asked about second mortgages, there are 8 reasons why you would consider a second mortgage:
- You have been declined for a personal loan
- The penalty to break your current mortgage contract is very large
- You don't qualify for a home equity line of credit (HELOC)
- You need financing for more than 80% of your home's value
- Your credit has been bruised and you need access to some of your home's equity to get back on track
- You are recently self-employed and you can't confirm your income with traditional lenders like banks and credit unions
- Your credit card debt is reaching the limits and you can't qualify for a consolidation loan
- You want to do some renovations to your home
Let's review these reasons for choosing a second mortgage. After that, we can discuss when and how to apply for a second mortgage. We can also review how long it takes and whether a second mortgage will hurt your credit or not.
1. You have been declined for a personal loan
If you have been declined for a personal loan and you have enough equity in your home, then a second mortgage could be an option.
Banks and credit unions will provide a second mortgage up to 80% of the value of your home less any outstanding mortgage balance. Private lenders will provide financing up to 85% to 90% of the value of your home, less any outstanding mortgage balance.
I believe that everyone should figure out for themselves if it's worth it to take out the second mortgage. Before you apply for the second mortgage, you want to ask yourself these questions:
- Why was I declined for a personal loan?
- What do I want this money for?
- Can I wait until I can get approved for a personal loan or do I need the money now?
- How much money do I need?
- How much will it cost to set up the second mortgage?
- Will I be in a better financial position by taking out a second mortgage?
Why was I declined for a personal loan?
It's important to review why you were declined and what will need to happen for you to be approved in the future. Possible reasons for a decline could be your income, your credit or you may have too much debt.
Income: Banks, credit unions and trust companies want to have confidence that you can afford the payments for a loan that you apply for. If you are not able to provide the documentation that they are looking for, then they could decline your loan.
If you work several jobs, or if you are self-employed or if you are a casual employee and pick up shifts when you need extra cash, banks want to look at your earning history. Therefore, they ask for several years of history of your income before they will approve you.
A private second mortgage lender doesn't have strict requirements. They will review the documents you provide and listen to your explanation of how you earn income. If they determine the risk is low enough for their liking, then you will be approved for a second mortgage.
Credit: Banks, credit unions and trust companies have fairly strict requirements for credit scores. If your score is below 620 or 600 then you aren't going to be approved for a loan.
If that's the case, then as you go through the process of applying for a second mortgage, you will also want to have a plan to improve your credit before the second mortgage is due. That is, put steps in place so that your financial position will improve because of this second mortgage.
Private lenders do care about your credit, but what they care about more is whether or not you will pay them back. If you don't pay the second mortgage lender back, then they can foreclose and get the money back eventually.
However, this process is expensive and they would rather you make payments for the next 1 or 2 years then pay off the loan in full at the end of the term.
The beacon score isn't as important to private lenders as is your character. If there is evidence that you are likely to make the payments and if it's reasonable that you can afford the payments, then they will likely provide you with the money you request.
Too Much Debt: This is the third reason that a bank or credit union or trust company in Canada would use to decline your application for a loan. These institutions have calculations that they perform with every client.
If the calculations they do with for your application results in a number that's too high, then they will turn you down. These calculations related to your income and other payments, etc. So this reason is closely tied to your income confirmation described above.
For private lenders, your debt is a factor, but if you are taking the second mortgage to pay off debts. If the second mortgage results in payments that are lower than the payments you are making now and you seem to be able to afford things, then you will likely be approved.
Home Value: For all of this discussion, the most important part of financing your home with a second mortgage is the value of your home. If there isn't enough equity in your home for the money you need, then you won't be approved for a second mortgage.
Let's look at how this is calculated because many clients ask about this.
Let's assume your home is worth $400,000. Let's also assume that you have a mortgage for $300,000 with payments of $1800/month.
80% of the value of your home is $320,000. A second mortgage to 80% of the value of your home would provide you with financing of $20,000 less set up fees. (That's calculated by subtracting the mortgage balance $300k from 80% of your home's value $360k)
85% of the value of your home is $340,000. A second mortgage to 85% of the value of your home would provide you with financing of $40,000 less set up fees.
90% of the value of your home is $360,000. A second mortgage of 90% of the value of your home would provide you with financing of $60,000 less set up fees.
The higher you borrow against the value of your home the higher the fees and interest rate because the private lender is taking more risk. Also, there are less private lenders willing to consider financing 90% of your home's value.
What do I want this money for?
You may want this money for several reasons. Let's review the top three reasons that I hear from clients about why they are looking for a second mortgage:
- Pay off debt
- Complete home renovations
- Invest in your business
- Pay income tax arrears
Pay off Debt
This is the number one reason that clients approach me for a second mortgage. They have accumulated too much debt and were declined by the bank for a consolidation loan.
In some cases, the clients have excellent credit and we can help them either refinance their home or set up a home equity line of credit and get them back on track.
In other cases, their credit is bumped and bruised or their income isn't what it used to be. In those cases, we help provide a second mortgage to ease the payment crunch that they are feeling.
The second mortgage can get their credit back on track and after a year or sometimes 2 years, they can set up a new first mortgage by refinancing the existing first and second mortgage into one.
I have also had situations that I've recommended that the clients sell their homes instead of taking the second mortgage. This is always an option and many people don't think of it.
However, if it's possible to sell your home, then you will get all the equity out of your home. You can rent for 6 months to a year, get back on track then buy your next home.
This is often a tough decision, but I believe that when you are considering any private mortgage financing options, selling your home should be one of the options.
Complete Home Renovations
Home renovations are a great reason to consider a second mortgage. If you don't qualify for a mortgage refinance or HELOC or if it's too expensive to refinance your home, then a second mortgage can help you access to cash to increase the value of your home.
I had a client who didn't qualify for traditional mortgage financing or any personal loans. He ex had lost his high paying job and she was no longer receiving the child support and alimony she was used to. She was working and managed to pick up extra shifts, but things were starting to fall behind.
Her home had an undeveloped basement. She applied for a $50k second mortgage to build a basement suite so that she could generate some additional revenue from her home. She built the suite and rented out the rooms through Airbnb and was making $1800 to $2000 per month on average.
This covered the loan payment and replaced the alimony/child support she had been receiving.
She had started working after her divorce and there was some opportunity for her to take on more responsibility at work with higher pay. She also started receiving profit share.
This second mortgage helped her to keep things on track when she had a dip in her cash flow.
Invest In Your Business
As a business owner, you may have opportunities that require a quick injection of cash. If you aren't able to get financing through traditional methods, then a second mortgage could be an option.
A client I was working with had an opportunity to purchase raw material for his business at a substantially reduced cost. His business line of credit didn't have the room and his business banker couldn't provide the funds necessary in the 5-day window he had.
He set up a second mortgage and received his funds within 4 days. He was able to purchase at a 75% discount to what he normally paid.
The cost of set up was far outweighed by the return on investment he would get by saving so much on the raw material.
This client was ecstatic with how quickly he could get access to the cash he needed where no one else would provide this to him that fast.
Pay Income Tax Arrears
If you owe income tax to CRA, then most lenders in Canada won't provide you with financing until these arrears are paid in full. Private second mortgage lenders are a solution.
You can set up a second mortgage to pay off your income tax arrears. After a year or 6 months, you can refinance your first and second mortgage to bring the overall rate and payments down.
It's usually self-employed clients who run into this issue. Something happens with their accounting. They fall behind with income taxes and the banks are not very helpful.
The bank wants the income taxes paid before they will provide financing. The client wants the financing to pay the income taxes. The client finds themselves at a catch 22.
Second mortgage lenders are a good solution. The private lender will ensure that you do pay the income tax arrears with the funds that are being released.
Typically, the private lender will set up the loan for a 1-year term and we refinance the home to bring everything into one low monthly payment.
Hopefully, you and your accountant have sorted out your payments to CRA so that this doesn't happen again.
Can I wait until I can get approved for a personal loan or do I need the money now?
If you have just been declined for a loan and you know why and you know what you might have to do so that you will be approved. Can you wait?
A second mortgage comes with costs. There are legal fees, appraisal fees, lender and broker fees. If you don't need the money right now and you can wait to take the steps necessary to fix things, then wait.
I've talked to many clients in this very situation. We review why they were declined. We talk about what they need to do to be approved in the future. Then I ask if they can wait. If the answer is yes, then it's best to wait.
Why incur additional fees, if you don't really need the money right away. If you can wait a month or 2 and you can get things sorted out in that time, then it's in your best interest to wait.
If you can't wait, then we can find a lender who will provide the money. We're happy to help!
How much money do I need?
This question is importantly related to the costs to set up a second mortgage. In some cases, you don't need a lot of money. If that's the case, then it might be cost-prohibitive to set up a second mortgage for a small loan amount.
When you speak with your mortgage broker (us preferably), then let us know how much money you need. There may be solutions that don't involve using your home as collateral and therefore will be at a much lower cost than if you set up a second mortgage.
How much will it cost to set up the second mortgage?
This question relates to the last one. If you aren't looking for a lot of money, then the cost of the second mortgage may make it prohibitive to set up the loan in the first place.
We have access to many lenders. Some will provide unsecured financing where banks will not. The cost to set up these unsecured loans is much lower than a second mortgage would cost you.
Will I be in a better financial position by taking out a second mortgage?
For me, this is your most important question. If you are going to proceed with a private second mortgage, then what is your plan for the future?
Do you have an action plan in place to improve your situation so that you can pay off this second mortgage at the end of the term? Pay it off either by refinancing the first and second mortgage or will you have access to cash to pay it off directly?
When I help clients with second mortgages, it's important to me to ensure that they are on the right track and will have an improved financial position. Whether it's improved cash flow and a plan to improve their credit, or for other reasons.
If you are considering a second mortgage, connect with us. Let's review these questions together so that you can make an informed decision and move forward with knowledge.
2. The penalty to break your current mortgage contract is very large
In Canada, the majority of mortgage contracts are closed. All mortgage lenders charge a penalty to break the contract before the end of the term. See our article about how mortgage penalties work here.
If your mortgage is with one of Canada's big banks, like TD or RBC, BNS, CIBC, etc. Your penalty could be very big. Many of the Monoline lenders, however, (that is, lenders who only deal in mortgages) offer much more favorable calculations for breaking your mortgage before the end of the term.
If your penalty is large, it may be a better option to set up a second mortgage instead of paying out your existing mortgage. Your options will depend on whether or not you qualify for financing with your current lender.
Before we go into the details about a second mortgage, let's review your options. Let's assume the penalty to break your mortgage is big (that is, over $8,000). You have xx options:
- Refinance the mortgage with your current bank.
- Apply for a Home Equity Line of Credit registered behind your existing mortgage
- Apply for a second mortgage
Refinance the mortgage with your current bank.
If you have a mortgage with a lender (big bank, or whatever), these lenders will often allow you to refinance your mortgage.
Some lenders will blend the interest rate that you have with today's rates and not charge a penalty. There can be restrictions where you can only choose the same term that is equal to the months remaining on your current mortgage. Some don't have these restrictions.
Some lenders will add the penalty to the new mortgage and give you a new mortgage. Be very careful here. If you are going to pay the penalty and you qualify for the mortgage, then you want to make sure they are giving you a competitive rate.
You are canceling this contract and you can shop for a better deal in this case. I've seen some situations where clients thought that they were getting a blended rate but paid a penalty and received a bad interest rate. That's not a good situation.
Some lenders currently offer mortgages with restrictions. When you chose the mortgage or at renewal the lender offered you a slightly lower rate but the mortgage didn't allow changed mid-term. These mortgages can't be broken without the sale of your home.
It's important to read the fine print when you set up your mortgage or renew your mortgage. I've seen a client who thought they received a good deal only to find out later that they were stuck with this lender until the end of the term.
They were essentially handcuffed. They had no choice but to apply for a second mortgage because they couldn't make changes to the current mortgage mid-term.
Apply for a Home Equity Line of Credit registered behind your existing mortgage
If your mortgage penalty is large and you don't have the option to refinance without incurring a penalty, then a home equity line of credit is the next best option.
A home equity line of credit can be registered behind your existing mortgage. Lenders will finance up to 80% of the value of your home minus the current mortgage balance. Rates are typically better than second mortgage rates and you can have more flexibility with a HELOC.
Some lenders will even pay the setup fees to arrange the HELOC for you. They pay the fees because they want the opportunity to take over the current first mortgage when it comes up for renewal.
You have options and choices when the mortgage comes up, so why not let them pay for the setup. You can negotiate than for a good deal whether it's with the HELOC provider or another lender entirely.
The downside to a home equity line of credit is that it can be harder to qualify for. If you don't qualify for a HELOC, then a second mortgage is your next option.
Check out the list of related articles at the bottom of this article for details about the pros and cons of HELOC's
Apply for a second mortgage
If you have explored the refinance option and the HELOC option and neither of those are a good fit for your situation, then applying for a second mortgage is your next option.
As I described earlier, a second mortgage can be a great fit if in the right situation. You want to ensure the second mortgage is going to help you move toward a better financial situation.
You also want to have an exit strategy. Set up the second mortgage with a maturity date equal to the maturity date of your current first mortgage.
This way, both will mature at the same time. You can take steps a few months before the maturity date to set up a new mortgage the pays both out at a better overall rate than you are currently paying.
If you have questions about your specific situation, connect with us. We are happy to review your options.
3. You don't qualify for a home equity line of credit (HELOC)
A second mortgage isn't the first option that I offer clients when they are looking for financing and it shouldn't be the first option that clients consider.
Usually, the best option for mortgage financing is a first mortgage or Home Equity Line of Credit. If you have a mortgage in place and don't want to pay it out or can't pay it out, then consider a HELOC.
Many lenders in Canada will offer Home Equity Lines of Credit to be registered in second position behind an existing mortgage. All of these lenders do have rules and regulations around this but chat with a broker who deals with all the banks instead of doing all the homework yourself.
One of the, little talked about, advantages of setting up a HELOC is that many banks will offer a promotion to pay legal fees or appraisal fees or both when you set up a HELOC with them.
This makes economic sense because they are capturing a good client. They use this as a stepping stone to garner more and more of your banking business. Then, when your current first mortgage matures, they try to switch that over as well.
For many years Home Equity Lines of Credit weren't very popular, but recently the HELOC has become much more popular. Every big bank will offer a version of the HELOC, under different names.
Clients like the flexibility of the HELOC and often have the option to lock in low mortgage rates with the HELOC as well. A win-win for clients. With this flexibility comes more strict qualifying criteria.
If you don't qualify for a HELOC because the qualifying criteria are much more stringent than a traditional mortgage, then a second mortgage is likely to be your next best option.
For more details, read our article about the pros and cons of a Home Equity Line of Credit.
4. You need financing for more than 80% of your home's value
Banks, trust companies, credit unions are regulated institutions. For most regulated institutions, the maximum financing that they can provide is up to 80% of the value of your home.
If you want to refinance your home above 80% of its value, then it doesn't matter if you qualify for the mortgage amount. Your lender will not be provide financing above 80% of the value.
This is where private lenders can come in. Private lenders don't report to the same governing bodies, therefore, they don't have the same strict qualifying requirements.
If however, you are in a specific situation where you are going through a marital break-up. There are programs that will allow you to finance up to 95% of your home's value. Check our article called, How to refinance your mortgage while going through separation or divorce.
I have seen many situations where clients need to access equity up to 85% or even 90% of their home's value. Private lenders will consider these.
The higher you want to go, the higher the fees and the interest rates, but it's possible. Like my advice throughout this article, make sure that you are making a choice based on improving your financial position.
Connect with us to review your options.
5. Your credit has been bruised and you need access to some of your home's equity to get back on track
If you have had some issues with your credit in the recent past, then most "A" lenders will not offer any solutions.
A private second mortgage is often a good solution to help you clean up the credit issues and get back on track with more reasonable payments and some relief.
In this situation, also consider the option of selling your home. When you set up a second mortgage, you don't have access to all the equity in your home. If you sell, you will receive all the equity, less real estate fees.
Sometimes, selling and paying off everything is a better option financially than paying to set up a second mortgage. You want to review the numbers and see what's best for you.
I have helped clients in this situation many times. Sometimes, the clients hadn't even considered selling their home. When they looked at the numbers and created a plan to buy their next home in the next 1 or 2 years, they felt so much relief.
I get paid to help you set up a second mortgage. I don't get paid if you decide to sell your home, but I believe that you should choose what's in your best interest! If it's selling your home, then that's what you should do.
6. You are recently self-employed and you can't confirm your income with traditional lenders like banks and credit unions
I wrote an article for self-employed clients. If you are self-employed, this is a must-read: I'm Self-Employed, How do I qualify for a mortgage?
As a self-employed individual, you do have options. If you are recently self-employed and don't have a track record in your industry, then traditional banks and credit unions, etc. aren't too flexible when it comes to self-employed income.
Second mortgages can be an option. If you aren't looking for financing above 80% of your home's value and the mortgage payout penalty for your current mortgage isn't too much, then a mortgage refinance could be a less expensive alternative.
It's best to chat with a mortgage broker, connect with us to review your options.
Your mortgage broker will be familiar with all the programs available for you and your specific situation. You will then have an informed decision regarding the financing and what helps you move forward.
7. Your credit card debt is reaching the limits and you can't qualify for a consolidation loan
This is one of the top reasons that clients approach brokers for a second mortgage. They have accumulated too much debt for various reasons.
They have been declined by their bank and want to start paying things off. Many banks will take the current credit card payments into account when qualifying for a new loan, even though the loan will pay out the credit card payments.
It sounds weird, but this is a conservative approach to lending, that many institutions have for consolidation loans. Private lenders don't lend like this. They don't want to throw their money away, therefore they will want to provide financing to you if they think you will be able to afford the payments.
They understand that when you pay off the credit cards, you won't have these payments anymore. They also know how much you are paying. If the new second mortgage payment is lower than your current payments, then it's reasonable to extrapolate that you will be in a better position and will be able to afford the second mortgage payment.
If you can get yourself bank on track by the end of the private second mortgage term, then you'll then be able to refinance the first and second mortgage to get into a mortgage with lower overall rates and payments.
8. You want to do some renovations to your home
Home renovations are probably the second biggest reason clients comet to me for a second mortgage. Much of the time, we set up a Home Equity Line of Credit or mortgage refinance rather than a second mortgage.
The reason clients don't end up with second mortgages is that there are refinance programs available that allow clients to get funds higher than 80% of the current home value.
Some bank representatives just don't know what's available for their clients when it comes to mortgages. These bank reps work for 1 bank and don't know the programs of other banks and lenders. Therefore, these bank reps will only offer solutions based on what they know.
Some lenders have programs where they will consider the improved value for financing. If you own a home and renovate. If after renovations, your home will be worth $100,000 more than it's worth today, then these lenders will provide you financing up to 80% of the improved value.
This can make the difference between choosing a second mortgage or a home refinance mortgage.
Whenever you are considering mortgage financing, talk to a broker. They are aware of program options with many different lenders and therefore can offer you more choice than if you just walked into your local bank.
Now that we have reviewed the reasons that you might consider a second mortgage, let's look at when & how to apply for a second mortgage.
When to apply for a second mortgage
We have talked about many reasons that clients would consider a second mortgage in this article. Let's review them here.
For you to consider a second mortgage, you must have adequate equity in your home and you may be experiencing one of these situations:
- You have bumped & bruised credit
- You don't have traditional income confirmation
- You need funds quickly
- You don't qualify for a personal loan
- It doesn't make sense to payout your existing mortgage
- You don't qualify for a Home Equity Line of Credit
- You want to finance more than 80% of the value of your home
All of these examples assume that you have adequate equity in your home to qualify. Private second mortgages can fund quickly, the lenders are much more flexible with income confirmation and credit scores.
How long does it take to get approved for a second mortgage?
A second mortgage with a private lender can be funded very quickly. Some private lenders can provide money within 48 hours, provided they receive all the documents that are looking for. Typically, private second mortgages can be approved within a day and funded in under a week.
Some private lenders will as for a third party appraisal and others will do their evaluation. Those that complete their evaluation will fund much faster than those who require a third party appraisal.
Does a second mortgage hurt your credit?
No, a second mortgage will not hurt your credit unless you are late making payments. All debt reports to the credit bureau and as long as you are making your minimum payments on time, the second mortgage will have a positive effect on your credit score.
If, however, you are late making these payments or in arrears, then a second mortgage, like any loan will hurt your credit report and your credit score.