Home Equity Line Of Credit vs. Private Second Mortgage

Whatever expense you need to cover — renovating your home, paying for college tuition, or fixing your car — there are loans available to help you pay for these costs. 

One unique way to get access to some extra cash is to tap into your home’s equity. If you are a homeowner, you may be able to use the equity in your home to secure a loan.

Your home equity refers to the difference between the market value of your home and the amount you still owe on your mortgage. If you have enough of it, you may be able to access it when a large expense comes your way. 

More specifically, you can use your home equity in the form of a second mortgage from a private lender or a home equity line of credit, typically from a traditional financial institution. Let’s take a look at each and see how they compare.

Ways To Access Your Home Equity 

A second mortgage refers to a home loan that is taken out on a home that already has a mortgage on it. It’s called a “second” mortgage because it comes second in line to a first mortgage in terms of loan repayment. 

The most common way for a homeowner with good credit to tap into their equity is via a home equity line of credit. 

But for those who have struggled financially in the past or who are looking for an alternative option, a second mortgage from a private lender is something to consider. 

Learn About Accessing Home Equity With Mortgage Broker Dave Johnson

What Is A Second Mortgage From A Private Lender?

A second mortgage from a private lender is a good option for homeowners who cannot get approved for a HELOC or mortgage refinancing and who are in need of short-term financing.

This type of second mortgage is a fixed amount of money and must be repaid via regular payments that include principal and interest. The amount you can borrow depends on the amount of equity you have built. When it comes to second mortgages, typically you can borrow up to 80% of the value of your house (LTV). But, when working with a private lender, you may be able to borrow more.

How To Qualify For A Private Second Mortgage

In order to qualify for a home equity loan, you’ll need to have a certain amount of equity in your home. Depending on the lender, you may be able to borrow up to 90% of the appraised value of your home. But, typically most lenders stick to 80% LTV. Other factors will also play a role in the amount you can borrow, such as your income, debt load, credit score, and the current market value of your home. 

How To Apply For A Private Second Mortgage

Getting a second mortgage is very similar to securing a first mortgage. The difference is you already own your home when you apply for a second mortgage. 

The process generally involves the following steps:

• Choose the right lender
• Complete the mortgage application process
• Supply all required documentation
• Allow for an appraisal of your home to be conducted
• Close on the loan when approved
• Get access to your money
• Pay the fees if required (either upfront or rolled into your payments)

Interest Rates For Private Second Mortgages

Interest rates associated with private second mortgages are generally lower than a personal loan, unsecured line of credit, and credit card rate. Largely because your home is a valuable asset that will back the loan. But your rate will likely be higher than the rate you have for your original mortgage.

In general, you’re looking at a rate of up to 15%. But of course, this depends on what type of borrower you are, how much money you need to borrow, and the lender you choose. 

Pros And Cons Of Second Mortgages

Private Second mortgages have their advantages and disadvantages that should both be weighed before you apply for one:

Pros

• Less Strict Qualification. Working with a private mortgage lender is a good option for homeowners who struggle with poor credit since the requirements are typically less strict.
• Lower Interest Rate. Compared to unsecured personal loans and credit cards, second mortgages typically come with much lower interest rates, saving you money in the long run. 
• Consolidate Debt. Rather than taking out several different loans, you may be able to use only the equity in your home to help cover the cost of various expenses, including post-secondary education or buying a new car. Or you can use a second mortgage to consolidate any high-interest debt you already have.

Cons

• Higher Rate Than First Mortgage. Lenders who hold second mortgages take on more risk than those who hold first mortgages. This is because if you ever default on your loan, the first lender will be paid off first. Whatever money is left over will go toward paying off the second lender. And if there’s not enough left in the pot, the lender holding the second mortgage could be left short-handed. 
• More Expensive Option. Second mortgages are the most expensive way to gain access to the equity in your home. 
• Additional Debt. Adding a second mortgage to the mix just adds more debt to your plate. Make sure you’re careful with your mortgage payments to avoid accumulating too much debt or putting yourself at risk of losing your home.

Additional Reading

Paying Off Your Mortgage Early In Canada

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Getting Pre-Approved For A Mortgage

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Advantages Of A Mortgage Broker

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What Is A Home Equity Line Of Credit?

A home equity line of credit — or HELOC — is different from a private second mortgage. Although they are still often referred to as a type of second mortgage. Most Canadian homeowners apply for a HELOC from the lender or bank that holds their first mortgage. 

A HELOC is a good option for homeowners who have good credit and need to access money on a regular basis.

With a HELOC, you can borrow as much as money you require, up to the limit of your credit line. You can also withdraw as little or as much as you need at any time without having to reapply for a loan. Rather than paying interest on the entire credit limit amount, you only pay interest on what you’ve withdrawn. Once you pay that amount back, you’ll have no more interest to pay until the next time you withdraw money. 

How To Qualify For A HELOC

Like a home equity loan, you need a certain amount of equity in your home to get approved. More specifically, you’ll need to have at least 20% to 35% equity in your home to access a HELOC product. 

As you can see, a HELOC works like a credit card.  But unlike a credit card, a HELOC is a secured loan product, which means your home is collateralizing the loan. These loans are great if you regularly need access to a large sum of money, for example, to pay for home improvements, without having to continuously apply for a new loan. 

HELOC Interest Rates

Most HELOCs come with variable interest rates, which means your rate can go up or down over the loan term. 

In general, you can expect an interest rate of up to 7%. This will of course depend on you and the lender you work with.

Pros And Cons Of A HELOC

HELOCs come with a few perks, but there are also some drawbacks to consider as well.

Pros

• Flexibility. With a HELOC, you’ll always have access to cash whenever the need arises. Just withdraw whatever you need — up to your credit limit. You will have regular payments to make and the full amount will need to be repaid within a certain time.
• Low-Interest Rate. The interest rate on your HELOC will usually be lower than that of a personal loan, and it’ll definitely be lower than what you’d be charged on your credit card.
• Only Pay Interest On What You Withdraw. Instead of paying interest on the entire credit limit, you’re only required to pay interest on the portion withdrawn. And once you pay that money back, you won’t have to worry about paying any more interest until the next time you make a withdrawal. 
• Easily Accessible. There’s no need to take out a new loan every time you need extra money. Instead, just tap into your home’s equity as the need arises. 

Cons

• Variable Interest Rate. The rate on your HELOC fluctuates over time, which means you could be paying a higher interest rate from time to time. Plus, this rate fluctuation might make it more difficult to budget. 
• More Strict Requirements. It can be more difficult to get approved for a HELOC which is why a second mortgage from a private lender is a good alternative option.

Private Second Mortgage & HELOC Fees

There are certain costs that you’ll incur when you apply for any type of second mortgage, including the following:

• Appraisal fees
• Title search
• Title insurance
• Legal fees

Private Second Mortgage vs. HELOC

Private Second Mortgage vs. HELOC: Which Should You Choose?

When deciding which loan product to choose if you want to use your home’s equity, consider the following.

When To Choose A Private Second Mortgage

• You know exactly how much you need to borrow
• You have a very specific one-time need for a large sum of money
• You prefer having a regular, fixed payment schedule

When To Choose A HELOC

• You’re not sure exactly how much money you need
• You want to access extra cash on a regular basis
• You don’t want to have to apply for loan after loan when the need for extra cash arises
• You like the flexibility of having access to cash just in case
• You want a lower interest rate compared to a credit card
• You’re comfortable with budgeting

Other Ways to Access Your Home Equity

In addition to a home equity loan or a HELOC, there’s another way to access the equity in your home, through a refinance. 

Refinancing Your Mortgage

Refinancing your mortgage involves replacing your current mortgage with a new one. To get access to extra cash, you’ll need to borrow more on the new mortgage compared to what you still owe on your current mortgage, leaving you with money left over. This is not only a great way to access your home’s equity, but it can also help you lock in at a lower interest rate if the current rate is a lot lower than your previous rate. 

It’s important to understand that you’ll have to pay interest on the amount of cash you borrow right away. Plus, you may be charged a penalty fee for breaking your mortgage early. Make sure the fees are worth the refinance.

Final Thoughts

Homeownership comes with several perks besides having your name on the title and a place to call home. It may also afford you certain loan products that you would otherwise not have access to. If you’ve got a certain amount of equity built up in your home and you need some extra cash from time to time, you may be able to access your home’s equity through a second mortgage or home equity line of credit.

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