Second Mortgages

If you need funds for a significant expense, you might consider using your home's equity.

A second mortgage is one way to access this equity without selling your home. This type of loan can be easier to qualify for compared to other financing options.

Key Points

A second mortgage allows you to turn a portion of your home's equity into a lump sum of cash for various expenses.

Since your home serves as collateral for the second mortgage, it can be easier to qualify for and may offer better interest rates. Home equity loans and Home Equity Lines of Credit (HELOCs) are two common ways to access this equity. Typically, you can borrow up to 80% of your home's appraised value through a second mortgage.

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What Is A Second Mortgage In Canada?

A second mortgage is a common way to tap into your home equity. Equity is the value your home gains as you pay down your mortgage, calculated by subtracting your remaining mortgage balance from your property's value. Once you have at least 20% equity, you can access various credit products secured against it, including second mortgages.

The term "second mortgage" indicates that this loan is second in priority if you default. This means that if you fail to repay your debts, the first mortgage will be paid off before the second mortgage from the proceeds of selling the property.

When accessing your home equity through a second mortgage, you have two main options: a home equity loan or a home equity line of credit (HELOC).

Home Equity Loan

A home equity loan is a secured loan that uses your home as collateral. It provides a lump sum of money that can be used for various purposes. The loan is repaid in installments over a set term, usually between 5 to 15 years, with interest charged on the entire loan amount.

Pros of a Home Equity Loan

• Fixed Payments: Payments are equally divided, making it easier to budget.

• Fixed Rates: Many lenders offer fixed interest rates that remain constant throughout the loan term, often lower than variable rates.

• Easier Qualifications: Generally easier to qualify for compared to unsecured personal loans, as the loan is secured against your home.

Cons of a Home Equity Loan

• Higher Interest Rate: The interest rate is higher than your first mortgage but typically lower than unsecured loans.

• Collateral at Risk: Your home is used as collateral, which means it could be at risk if you miss too many payments.

Home Equity Line of Credit (HELOC)

A HELOC operates similarly to a credit card, allowing you to withdraw from a revolving credit limit. You can make minimum monthly payments or pay off your balance to restore your full credit limit.

Typically, you can borrow up to 65% of your home's value with a HELOC. Interest rates are usually variable, meaning they fluctuate based on an index, which can make your monthly payments less predictable compared to a home equity loan.

Pros of a HELOC

• Interest on Usage: Interest is only charged on the amount you borrow. Once you repay what you've withdrawn, no further interest is charged. Unlike a home equity loan, you only pay interest on the amount you use.

• Quick Access to Funds: A HELOC provides a readily available source of funds without needing to apply for a new loan each time an expense arises.

• Flexible Payments: You can make multiple, partial, or minimum monthly payments until the draw period ends (usually around 10 years). After the draw period, you must start paying off the principal and interest with regular payments.

Cons of a HELOC

• More Interest: You might end up paying more interest overall if you don't consistently make full payments.

• Variable Rate: Variable interest rates can be higher than fixed rates, especially if the prime rate rises during your term.

• Fees: Many lenders charge an annual fee to keep the HELOC open.

• Collateral: Your home is used as collateral, so failing to pay your HELOC could result in losing your home, similar to a home equity loan.

HELOC Vs Home Equity Loan

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How Much Can You Borrow Through A Second Mortgage?

The amount you can borrow with a second mortgage can be calculated using this formula:

Property value x maximum borrowing amount – remaining mortgage amount

Let's go through an example to illustrate this calculation:

1. Determine the property value: Suppose your home is valued at $500,000.

2. Maximum borrowing amount: Typically, you can borrow up to 80% of your home's value. So, 80% of $500,000 is $400,000.

3. Subtract the remaining mortgage amount: If you still owe $200,000 on your first mortgage, you subtract this from the maximum borrowing amount.

So, the calculation would be:

$500,000 times 0.80 - $200,000 = $400,000 - $200,000 = $200,000 

In this example, you could borrow up to $200,000 with a second mortgage.

What Can You Use A Second Mortgage For?

Although the idea of home equity may be confusing at first, it can be a huge commodity, considering all the ways you can use it to your advantage. In fact, most Canadian homeowners dip into their home equity at one point to:

Here are some common uses for a second mortgage:

• Consolidate Debts: Combine multiple debts into one manageable payment.

• Pay for Home Renovations: Fund improvements or repairs to your home.

• Finance a Car: Purchase a new or used vehicle.

• Start a Business: Get the capital needed to launch a new business venture.

• Cover Higher Education Fees: Pay for tuition and other educational expenses.

• Make Large Purchases: Buy big-ticket items like appliances or furniture

Pros and Cons of Borrowing Against Your Home

Using your home equity can be beneficial in many situations, but it's crucial to understand the potential advantages and disadvantages, as they can significantly impact your lifestyle.

Pros of Borrowing from Your Home Equity

• Large Loans: With sufficient equity, you can access substantial funds over a long period without needing to sell your home.

• Alternative to Refinancing: Instead of refinancing your home to access extra cash, you can opt for a second mortgage, potentially saving on costs like closing fees.

• Favorable Interest Rates: If you have significant equity and strong financial health, you may secure better interest rates compared to unsecured credit products.

Cons of Borrowing from Your Home Equity

• Additional Payment: A second mortgage is a new loan, meaning you'll have an extra payment on top of your first mortgage. This can strain your finances and, if mismanaged, lead to debt, damaged credit, or even foreclosure.

• Fees: The lending process involves various costs, including loan origination, appraisal, accounting, and legal fees.

• Reduced Equity: Taking out a second mortgage reduces your home equity and increases your overall debt load.

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Eligibility Requirements for a Second Mortgage

To qualify for a second mortgage, you generally need to meet the following criteria:

• Home Equity: Have at least 20% equity in your home.

• Credit Score: Maintain a good credit score, typically at least 650.

• Debt-Service Ratio: Have an acceptable debt-service ratio, with no more than 39% Gross Debt Service (GDS) ratio or 44% Total Debt Service (TDS) ratio.

Keep in mind that individual lenders may have specific requirements. Their minimum credit score or debt-service ratio thresholds might vary slightly. It's essential to consult with your lender directly to understand their exact qualifications for a second mortgage.

Using your home equity can be beneficial in many situations, but it's crucial to understand the potential advantages and disadvantages, as they can significantly impact your lifestyle.

Where Can I Get a Second Mortgage in Canada?

Second mortgages are available from various lenders in Canada:

Traditional Lenders

You can apply for a second mortgage through conventional banks or credit unions. These institutions have stringent lending criteria, typically requiring a good credit score, strong income, and a low debt-service ratio.

Alternative Lenders

If you have sufficient home equity but face challenges like poor credit or a higher debt-service ratio, alternative lenders might be a better option. These lenders place more emphasis on your home equity rather than traditional loan requirements.

To qualify for a second mortgage, you generally need to meet the following criteria:

• Home Equity: Have at least 20% equity in your home.

• Credit Score: Maintain a good credit score, typically at least 650.

• Debt-Service Ratio: Have an acceptable debt-service ratio, with no more than 39% Gross Debt Service (GDS) ratio or 44% Total Debt Service (TDS) ratio.

Do I Need to Pass a Stress Test for a Second Mortgage?

To qualify for a HELOC with a conventional federally-regulated lender, such as a major bank, you must pass the mortgage stress test. This test is required when you first take out a mortgage and ensures you can afford the loan at the minimum qualifying rate. Currently, you need to qualify at the benchmark rate of 5.25% or your contract rate plus 2%, whichever is higher.

For a HELOC, you also need to pass this stress test. If you prefer to avoid the mortgage stress test, consider applying for a HELOC with an alternative lender or a non-federally regulated credit union.

These lenders are not bound by the same strict rules and regulations as big banks, so they might not require the stress test as part of their loan process. However, they may still choose to implement it at their discretion.

Final Thoughts

Tapping into your home equity can be an excellent way to secure substantial funds for major expenses or to consolidate high-interest debt. However, it's important to weigh the potential downsides, such as the risk to your home and the additional payments you'll need to manage. If you're considering using your home equity, feel free to reach out to Loans Canada. We can connect you with a licensed third-party specialist to help you find the right financing solution.

Second Mortgage | FAQs

Do I need good credit to borrow using my home equity?

The main factors your lender will examine when you apply for a second mortgage in Canada are your total home equity and overall ability to make payments. So, in certain cases, your credit will not be a major factor, like with a reverse mortgage. However, lenders will generally require you to have a good credit score of at least 650 to qualify for a home equity loan or HELOC.

I bought my house last year, can I get a home equity loan?

Generally speaking, you’ll need at least 20% equity built up to get a home equity loan. You would need to have made a large down payment of at least 20% of the purchase price when you bought your home, or wait until your home appreciated enough to reach 20% equity.

What happens to my second mortgage when I sell my property?

Typically, two scenarios can play out. You will either need to back your second mortgage in full before the sale of the house, or you’ll need to use the proceeds from the sale of your house to pay off your debt.

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Can I pay off my second mortgage early?

You can repay your second mortgage early, but be wary of early prepayment penalty fees. Review your loan contract or speak with your lender to find out if these penalty fees will apply if you pay off your second mortgage early, and if so, how much they are.

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