Second Mortgages

Equity is an asset that your home accumulates as you pay down your mortgage. The amount of equity in your home is calculated by tallying up the estimated real estate value of your property and subtracting the balance remaining on your existing mortgage. Once you have at least 20% equity, you’ll be able to access a variety of credit products that are secured against it. 

What Is A Second Mortgage? 

The most common way to access your home equity is through a second mortgage. 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 lump sum of money that will be directly deposited into your bank account. The loan is of course secured by your home equity and will need to be repaid through installments, typically anywhere from five to fifteen years. Interest will be 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.

Cons Of A Home Equity Loan

  • Higher Interest Rate – The interest rate on a home equity loan will be higher than your first mortgage. 
  • Collateral – 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 85% of the value of your house. 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. Unlike a home equity loan, you don’t have to pay interest on the entire balance, on 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. 
  • Payments Are Flexible – 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 ended 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 to pay your HELOC, you could lose your home as it’s used as collateral.

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

How Much Can You Borrow Through A Second Mortgage? 

The amount you can borrow can be calculated by taking the total value of your property multiplying it by the maximum borrowing amount and then minus the product by the mortgage left. 

Home Value$650,000
Maximum Borrowing Amount80% of home value
Mortgage Left$300,000
Amount You Can Borrow$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 home buyers dip into their home equity at one point in order to:

  • Consolidate Debts 
  • Pay For Home Renovation 
  • Finance A Car 
  • Start A Business 
  • Cover Higher Education
  • 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

  • Large Loans – With enough equity, you can gain access to a significant amount of money over a long period of time, without having to sell your home.
  • Alternative To Refinancing – Rather than refinancing your home to cover a purchase or renovation, you can get a second mortgage. This can help you save on costs such as closing fees.
  • Good Interest – Applying with a lot of equity and healthy finances can earn you better interest rates than with unsecured credit products. 

Disadvantages

  • Extra Payment – Unlike refinancing, a second mortgage is a new loan, meaning you’ll need to make another payment on top of your mortgage. This can be tough on your savings and, if handled irresponsibly, can lead to debt, damaged credit, and even the foreclosure of your home.
  •  Fees – There are many other costs associated with the lending process, including loan origination, appraisal, accounting, and legal fees.  
  • Hard To Qualify – It can be hard to qualify for favourable home equity products if you have bad credit, a low household income, or if you’re a new homeowner
  • Lower Equity – The more mortgage debt you take on, the less equity your property will retain.   

Second Mortgage FAQs

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

The main elements that your lender will examine when you apply 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, generally, lenders will require you have a credit score of 650 to qualify for a home equity loan or HELOC. 

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

Generally, you’ll need at least 20% equity built up to get a home equity loan. If you made a large down payment or your property appreciated in value over the year, you may have enough equity in your home to qualify for a home equity loan.  

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

Typically there are two scenarios that can play out. Your lender requires that you pay back your second mortgage in full before the sale of the house or they allow you to pay off your debt using the proceeds from the sale of your house.

Contact Loans Canada For All Things Home Equity

Borrowing using your home equity may seem like a complicated process but it is a great option for those consumers looking to access larger amounts or pay down high-interest debt. If you’re looking 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.

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

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