Second Mortgages

If you need a loan to cover a big expense, you may be able to tap into your home’s equity for the money.

One way to access your home’s equity is through a second mortgage. You won’t have to sell your house to use the equity, and you may be able to qualify for this type of financing more easily compared to other loans. 

Key Points

• A second mortgage lets you convert some of the equity in your home into a lump sum of cash you can use to cover various expenses.
• Your home collateralizes your second mortgage, which may help you qualify for the loan more easily and take advantage of better rates.
• Home equity loans and HELOCs are two types of financing that allow homeowners to access their home equity. 
• The most you can borrow through a second mortgage is 80% of the appraised value of your home.

What Is A Second Mortgage In Canada? 

The most common way to access your home equity is through a second mortgage. Equity is an asset that your home accumulates as you pay down your mortgage and is calculated by subtracting your remaining mortgage balance from the value of your property. Once you have at least 20% equity, you’ll be able to access a variety of credit products that are secured against it, including second mortgages. 

The term “second mortgage” is used because the loan is second in priority in case of default. This means that if a borrower defaults, the first mortgage will be paid off before the second mortgage if the property is sold to pay off the debt. 

When choosing to access your home equity via a second mortgage, you’ll have two products to choose from: a home equity loan or a home equity line of credit (HELOC).

Home Equity Loan

A home equity loan is a type of loan that is secured against your home. Like other loan types, a home equity loan provides you with a lump sum of money that you can use for a variety of purposes. The loan is repaid through installments over a set term, typically anywhere from 5 to 15 years, with interest charged on the full loan amount.

Pros Of A Home Equity Loan

• Fixed payments – With a home equity loan you’ll have equally divided payments, which can be easier to calculate and budget. 
• Fixed rates – Many lenders charge fixed interest rates that won’t change during your loan term and are sometimes lower than variable rates.
• Easier qualifications – Compared to other loan types, like unsecured personal loans, home equity loans are generally easier to qualify for because they’re secured against your home.

Cons Of A Home Equity Loan

• Higher interest rate – The interest rate on a home equity loan will be higher than your first mortgage. That said, the rate is typically lower than other unsecured loans.
• Collateral at risk – A home equity loan uses your house as collateral, which could put your home at risk if you miss too many payments. 

Home Equity Line Of Credit (HELOC)

A home equity line of credit (HELOC) functions more like a credit card, in that you’re able to withdraw from a revolving credit limit. You can choose to make minimum monthly payments or pay off your balance to regain access to your full limit. 

Typically, you will be able to borrow up to 65% of the value of your house with a HELOC. Interest rates are usually variable and thus fluctuate based on an index. This will affect your monthly payments and make them less predictable than the payments associated with a home equity loan.

Pros Of A HELOC

• Interest is charged on what you use – With a HELOC, interest is only charged on the amount you borrow. Once you pay back what you’ve withdrawn, no more interest is charged. Unlike a home equity loan, you don’t have to pay interest on the entire balance, only the amount you use from your credit limit. 
• Quick access to funds – Rather than applying for a loan when an expense comes up, a HELOC is a source of funds you can access at any time. 
• Flexible payments – With a HELOC, you can choose to make multiple, partial, or minimum monthly payments until the draw period ends (around 10 years). Only once the draw period ends are you obligated to start paying off the principal and interest with regular payments. 

Cons Of A HELOC

• More interest – You might pay more interest overall if you don’t consistently make full payments.
• Variable rate – Variable interest rates will apply, which can be higher than fixed rates (if Canada’s prime rate rises during your term).
• Fees – Many lenders charge a yearly fee to keep the HELOC open.
• Collateral – If you fail to pay your HELOC, you could lose your home as it’s used as collateral, as is the case with a home equity loan.

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.

HELOC Vs Home Equity Loan

How Much Can You Borrow Through A Second Mortgage? 

The amount you can borrow can be calculated using the following equation:

Property value x maximum borrowing amount – remaining mortgage amount 

Let’s illustrate how you can calculate the amount you can borrow with a second mortgage in Canada using an example: 

When you plug in the above figures, the formula will look like this:

• ($650,000 x 80%) – $300,000
• = $520,000 – $300,000
• = $220,000

In this example, the most you can borrow through a second mortgage is $220,000.

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:

• Consolidate debts 
• Pay for home renovations 
• Finance a car 
• Start a business 
• Cover higher education fees
• Make large purchases

Advantages And Disadvantages Of Borrowing Against Your Home

Although using your home equity can help in many scenarios, it’s important to understand the potential benefits and drawbacks, as they can impact your lifestyle. 

Advantages Of Borrowing From Your Home Equity

• Large loans – With enough equity, you can access significant money over a long period, without selling your home.
• Alternative to refinancing – Rather than refinancing your home to free up extra cash, you can get a second mortgage. This can help you save on costs such as closing fees that would apply with a refinance.
• Good interest rates – Applying for a second mortgage with a lot of equity and healthy finances can earn you better interest rates than unsecured credit products. 

Disadvantages Of Borrowing From Your Home Equity

• Extra payment – Unlike refinancing, a second mortgage is a new loan, which means you’ll need to make another payment on top of your first mortgage payment. This can be tough on your savings and, if handled irresponsibly, can lead to debt, damaged credit, and even the foreclosure of your home if you default.
• Fees – There are many other costs associated with the lending process, including loan origination, appraisal, accounting, and legal fees.  
• Reduced equity – When you pull equity out of your home in the form of a second mortgage, you’re effectively reducing your equity. Plus, you’ll be adding more debt to the pile.   

Eligibility Requirements For A Second Mortgage

To qualify for a second mortgage, you must meet the following criteria:

• Have at least 20% equity in your home
• Have a good credit score (at least 650 is suggested)
• Have an acceptable debt-service ratio (no more than 39% Gross Debt Service (GDS) ratio or no more than 44% Total Debt Service (TDS) ratio) 

Individual lenders have specific criteria that you’ll have to meet. For instance, their minimum credit score or debt-service ratio requirements may differ slightly. You’ll need to speak with your lender directly to find out exactly what you need to qualify for a second mortgage with them.

Where Can I Get A Second Mortgage In Canada?

Second mortgages are available from a variety of lenders in Canada: 

Traditional Lenders

You can apply for a second mortgage from a conventional bank or credit union. These lenders have strict lending requirements. You’ll typically need a good credit score, a strong income, and a low debt-service ratio to qualify for a second mortgage.

Alternative Lenders

If you have enough equity in your home to qualify for a second mortgage but have poor credit or a higher debt-service ratio, you may have better luck applying with an alternative lender. These lenders focus more on your home equity than other traditional loan requirements. 

Do I Need To Pass A Stress Test For A Second Mortgage?

To qualify for a HELOC with a conventional federally-regulated lender, like a big bank, you’ll need to pass the mortgage stress test. These tests are required when you first take out a mortgage and require you to be approved for a mortgage at the minimum qualifying rate. Right now, you must qualify at the benchmark rate of 5.25% or your contract rate plus 2%, whichever is greater. 

In addition to a first mortgage, a HELOC also requires you to undergo and pass this stress test. If you want to avoid the mortgage stress test, you may consider applying for a HELOC with an alternative lender or non-federally regulated credit union. 

These lenders don’t follow the same stringent rules and regulations as big banks, so they may not require the stress test as part of the loan process. However, they may choose to do so at their discretion. 

Additional Reading

Using a Second Mortgage to Buy a Car

Bi-Weekly Payments vs. Monthly Mortgage Payments

What Is A Purchase Plus Improvements Mortgage?

Final Thoughts

Borrowing from your home equity can be a great option if you’re looking to access larger amounts to cover big expenses or to pay down high-interest debt. Just make sure you’ve considered the potential drawbacks, including putting your home at risk and the extra payments you’ll need to make. If you want to dip into your home equity, don’t hesitate to contact Loans Canada. We can help match you with a third-party licensed specialist who can help you find the financing you need.

Second Mortgage FAQs

Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service