If you’re a homeowner looking to take equity out of your home (i.e., you require additional funds) in the form of a second mortgage, it’s critical to understand what a second mortgage is and the requirements and risks of one.
A second mortgage is when a homeowner borrows against the equity of their own home. So, while another mortgage gives you buying power, it’s a higher-risk loan with different interest rates and fees.
Your second mortgage does not replace your first mortgage contract but runs in parallel with it. In addition, it sits “behind” your first mortgage – meaning, if you default on your mortgage, the first lender has priority to collect the funds and then the second lender collects.
Borrowing against your home is not a decision to take lightly. Below, we look at understanding what a second mortgage is, the requirements, and the other options available to you.
Understanding Second Mortgages
Second mortgages in Canada are often more affordable than unsecured loans and credit, simply because they are secured by home equity accumulated over time. If you’ve paid off a portion of your current mortgage and you’re considering applying for a second mortgage, banks will look at this equity amount to determine if you can pay off a new loan.
But this can get tricky for people who are eager for cash flow or need to pay off other debt, leading them to take on more risk and debt in the long term.
Reasons People Have a Second Mortgage
It’s common for homeowners to see a second mortgage as a fail-safe fund. However, it’s more of a temporary fix than a long-term solution for many individuals.
Common reasons why people take out a second mortgage:
- Improved liquidity
- To buy time
- Prevents a home foreclosure
- Consolidate high-interest debt
- Not enough funds to pay off the existing mortgage, due to a layoff or illness
- Home improvement (e.g., renovations)
- Avoiding a penalty on your current mortgage
Second Mortgage Requirements
What qualifies you for a second mortgage is heavily based on your financial situation: your current income, credit and payment history, and the amount of equity you have in your first home. Your income is a big one, as your lender needs to see that you have a regular income that can pay off both mortgages.
Credit Score: A good credit score, 600 to 900, will make it easier for you to qualify for another mortgage. A poor credit score may jeopardize your ability to get a mortgage.
3 Reasons to Say No to a Second Mortgage
- Other options. While the lure of extra funds from an existing secured loan is enticing, consumers should also consider other financial tools, such as the HELOC (Home Equity Line of Credit) and refinancing, as financial alternatives to a second mortgage.
- High-Risk. A second mortgage is high-risk for both the borrower and the lender, because it often comes with higher interest rates and fees, as the borrower is considered a high-risk client who has two mortgages to pay.
- Behaviour Risk is the consumer’s own risk of not repaying debt. While a second mortgage gives you greater financial freedom (increased cash flow) at the beginning, you’re still on the hook to pay the interest and fees that will pile up if not paid in full.
Clear-Eyed Decision Making
While there are pros and cons to every financial decision you make, applying for a second mortgage can carry a lot of weight when it comes to looking at your financial background, your spending habits, and your ability to repay the money owed.
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