What Most Canadians Don’t Know About Second Mortgages...

Originally published on CanadianMortgagesInc.ca.

If you’re a Canadian homeowner, you’ve probably heard about second mortgages. But what is a second mortgage, and what do you need to know about them?

 A second mortgage is a type of loan that is secured by your home, similar to a first mortgage provided by a traditional bank. Over time you build up equity in your house, and a second mortgage allows you to use the equity you’ve built up. It is your money after all!

According to Business Insider, there are over “1.91 million Canadians with HELOCs, and even more with a second mortgage.” A HELOC, or home equity line of credit, is a type of second mortgage, as you’re basically adding a second loan on top of your existing loan in order to access equity.

Yet despite their prominence, second mortgages and loans are not well understood or properly leveraged by Canadians.

Here are 12 things that you likely didn’t know about second mortgages, which can help you get the most out of an asset that you’ve built equity in.

1. There are different types of second mortgages

What exactly is a second mortgage? These loan products come in a couple of different forms. For instance, a revolving HELOC offers the borrower continuous access to equity as they pay off what they previously owe (the principle), much like how a credit card works.

This type of loan can also be a closed second mortgage, which means that you get one lump sum of cash from your equity, and gradually pay it down, much like an auto loan.

HELOC’s are typically only offered to those in urban areas who have a strong credit profile. If you are experiencing credit challenges or limited income, private mortgages are likely your only option.

2. There are two common uses of second mortgages

The most common usage of a second mortgage is to pay off high-interest consumer debt or to use the funds for home renovations or upgrades. With the average credit card interest rate being 15%, you could save a lot of money by leveraging a second mortgage.

If you have a credit card balance of $30,000, for instance, your minimum monthly payment will be around $600 a month (assuming a 3% minimum payment requirement). If your credit card interest rate is 15% APR, this will cost you about $4,500 in interest in just your first year, before you even touch the principal amount you owe.

So many people are adding a second mortgage, paying off the credit card with that, and then enjoying a much reduced interest rate because a second mortgage is secured by an asset: your home.

3. Your home is collateral

When you take out a second mortgage, you are using your home as collateral to the lender. This means that if you do not pay, the bank has the option to foreclose just as it does with a first mortgage. That said, because you have a physical asset backing your loan, your interest rate will be substantially lower.

4. The power of interest-only payments

For many second mortgage products, you can elect to only make payments on the interest. This creates lower monthly payments, and allows you to have affordable access to the equity in your home before you are ready to sell.

Consider someone who wants to remodel before selling their home or renegotiating their primary mortgage. They can take second mortgage, use those funds to renovate, making interest-only payments. When it comes time to sell or renew, the home is valued at a higher price thanks to the renovations, and then the homeowner pays off the second mortgage.

5. Can be used to avoid PMI

When you apply for a conventional mortgage, if you do not have 20% to use as a down payment you will be required to obtain private mortgage insurance (PMI). In Canada, this is what we typically refer to as your Canadian Mortgage and Housing Corporation (CMHC) fees. And they can be quite high!

On a $500,000 mortgage loan with 5% down, you will be paying 4% CMHC fees. That’s a total of $19,000!

Taking out a second mortgage along with the first mortgage is one way borrowers can avoid PMI. A second mortgage can add a monthly payment to your budget, but can be a cheaper option than PMI.

6. You can use your equity for…Anything!

One of the most attractive benefits of buying a home is the potential to use the equity you have built up over time. Why let it sit there? Let that money you’ve earned start working for you!

You can use the funds however you’d like, but many people choose to use a second mortgage for home improvements, other investments, a child’s college education, an emergency fund, and more.

One popular usage of a second mortgage is to make an investment, like buying a rental property. Instead of saving up 20% for a down payment, you can tap into the equity of your existing home. The bonus of using a second mortgage for investment purposes is that the entire interest on that loan now becomes a tax deduction.

Continue reading the rest of "12 Things Canadians Don’t Know About Second Mortgages" over at CanadianMortgagesInc.ca

Originally written by Glenn Carter