Tag: second mortgage vs home equity loan

Are you considering getting a second mortgage on your home to access some of the equity you’ve built?

With real estate values rising in many parts of the country, tapping into your home equity can provide funds for renovations, debt consolidation, investing, and more.

However, second mortgages also come with risks and costs that must be weighed carefully before moving forward. This comprehensive guide will explore everything you need to know about obtaining a second mortgage in Canada for 2024 and beyond.

What is a Second Mortgage?

A second mortgage is any additional loan secured against a property that already has a first mortgage registered against it. It allows homeowners to leverage the equity they have accumulated in their homes.

Equity represents the difference between the current market value of your property and what you still owe on your original mortgage. For example, if your home is worth $600,000 and you have $300,000 left on your first mortgage, you have $300,000 in equity.

Why should I have a Second Mortgage?

There are several reasons a homeowner may choose to take out a second mortgage loan, including:

• Debt consolidation – Pay off higher interest debts like credit cards with a lower rate second mortgage
• Home renovations – Fund major home upgrades, additions, or repairs
• Investing – Leverage equity to invest in rental properties, a business, or other investments
• College expenses – Pay for yourself or your children’s education costs
• Car purchase – Buy a new vehicle
• Vacation property – Use equity from the current home for a down payment on a secondary recreational property.
• Avoid power of sale – Access cash to pay mortgage arrears and avoid foreclosure on a distressed property.

While second mortgages provide flexibility, they also come with considerable risks that homeowners must understand fully. We’ll explore those in more detail later in this guide.

How does a Second Mortgage Work?

When you take out a second mortgage, the lender provides you with money up to a certain percentage of your home’s value. Like your first mortgage, this loan is secured against your home as collateral.

However, the second mortgage is registered in a subordinate position behind your existing first mortgage. If you default, the first mortgage lender gets paid back before the second mortgage lender.

You make monthly payments on the second mortgage loan over a defined repayment term, usually 1-10 years. These payments pay back the principal loan amount plus interest.

A second mortgage works much like a first mortgage, except it is a separate additional loan that takes second priority on your home’s title and equity position.

Second Mortgages in the form of a HELOC

A HELOC is a revolving line of credit secured against your home, similar to a credit card. The lender approves you for a set limit, and you can withdraw funds up to that limit as needed.

HELOCs have variable interest rates that fluctuate with the prime rate. They usually only require monthly interest payments on the outstanding balance, not the principal.

Pros	Cons
Access to revolving credit as needed Variable rates can start low Interest may be tax deductible	Variable rates can rise over time Risk of overspending with credit access No forced principal repayment

Home Equity Loans

Also known as a second mortgage loan, this provides you with a one-time lump sum. The loan will have set repayment terms, such as 5 years, and can have a fixed or variable interest rate.

Pros	Cons
Single payout meets large cash needs Fixed-rate offers predictability Forced principal repayment	Fixed terms have less flexibility Loan limits borrowing amount Early repayment fees may apply

Read more: Home Equity Loans vs HELOCs in Canada

Private Second Mortgages

Private lenders, such as mortgage investment corporations, offer second mortgages outside the mainstream banking channels. They may have more flexible qualification requirements but charge higher interest rates and fees.

Pros	Cons
Can borrow up to 95% of home value More flexible approval criteria Access to cash when banks decline	Much higher rates and fees Riskier terms and requirements Private lenders are less regulated

Maximum Loan Size for Second Mortgages

The maximum amount you can borrow with a second mortgage ultimately depends on your available equity. Lenders will only let you borrow up to a percentage of your home’s value, minus what you still owe on your first mortgage.

Typical second mortgage loan-to-value ratios in Canada include:

• HELOCs – Up to 65% of home value
• Home Equity Loans – Up to 80% of home value
• Private Mortgages – Up to 95% of value

For example:

If your home is worth $600,000 and your first mortgage balance is $300,000, you have $300,000 of equity built up.

With a HELOC at 65% loan-to-value, you could qualify for $195,000 in revolving credit.

A home equity loan at 80% loan-to-value would allow you to borrow $240,000 as a lump sum.

And a private lender at 95% loan-to-value may approve you for a second mortgage up to $285,000.

These scenarios assume you meet the lender’s other qualification criteria. The maximums represent what you could borrow, not necessarily what you should borrow. It’s critical to only leverage an amount that fits comfortably within your budget.

Second Mortgage vs Home Equity Loan vs HELOC

In Canada, home equity loans often specifically refer to second mortgages. The “second mortgage” terminology refers to its subordinate ranking behind your original first mortgage in priority.

Essentially, there is no significant difference between a second mortgage and a home equity loan. The terms are often used interchangeably by lenders, brokers, and borrowers. They are two terms for the same thing – an additional loan secured against the equity in your home.

Home equity lines of credit (HELOCs) have distinct advantages and disadvantages compared to standard second mortgage loans.

Flexibility

HELOCs provide flexible access to revolving credit as needed, while a home equity loan provides a single fixed amount. This flexibility can be beneficial for homeowners who have changing borrowing needs.

Interest Rates

HELOCs have variable interest rates tied to the prime rate. Home equity loan rates can be fixed or variable. Predictable fixed rates help with repayment budgeting.

Available Funds

HELOCs allow you to draw on as much or as little of the approved credit limit as needed. With a lump sum loan, once the funds are advanced, you cannot borrow more without applying again.

Payments and Amortization

HELOCs typically only require monthly interest payments on the outstanding balance; there is no forced principal repayment. Home equity loans usually involve amortized payments, paying the principal and interest over a schedule.

Which is better depends on your specific financial situation. HELOCs offer more flexibility and access to funds, while a home equity loan provides fixed, predictable payments on a predetermined amount.

Qualifying for a Second Mortgage in Canada

Getting approved for a second mortgage involves similar criteria as qualifying for a first mortgage:

Equity

You must have at least 20% equity, but most lenders prefer 35% or more. Substantial equity reduces the lender’s overall risk.

Credit Score

Most mainstream banks require a minimum credit score of 650 or higher for approval. A score over 700 will get you better interest rates. Private lenders may work with lower scores but charge higher rates to offset the increased risk.

Income Verification

Lenders need stable employment income that comfortably supports your first and second mortgage payments. Self-employed borrowers may need to provide additional documentation, such as tax returns. A low debt-to-income ratio (under 40%) helps demonstrate your ability to handle the additional debt load. [Source]

Property Appraisal

The lender will base the maximum loan amount on a professional appraisal of your home’s fair market value. This also reassures them that the property would recoup the loan amount if they had to foreclose and sell.

Meeting these criteria does not guarantee approval, but they demonstrate attributes that make a borrower a lower risk in the eyes of potential lenders.

5 Steps to Get a Second Mortgage in Canada

1. Check you have sufficient home equity
2. Review lenders and mortgage rates, choosing the option that aligns with your borrowing needs and budget.
3. Submit your application with all required documents and information
4. Get your home professionally appraised if required by the lender
5. Upon approval, review mortgage terms, disclose conditions, and complete legal documentation

Second Mortgage Rates in Canada

Interest rates on second mortgages are almost always higher than rates on first mortgages:

• HELOCs – Prime + 0.5% to Prime + 2.0%
• Home Equity Loans – Prime + 1.0% to Prime + 3.0%
• Private Mortgages – Prime + 2.0% to Prime + 6.0%

These ranges represent your pay depending on your credit score, income, equity position and property type.

The increased interest accounts for the higher risk lenders take on with a second mortgage. First mortgages take precedence, so second mortgage lenders know recouping their funds in a default situation carries more uncertainty.

Second mortgage rates can still be much lower than credit card or personal loan interest. And in a low-rate environment, even a high rate may be reasonable compared to historical norms.

Second Mortgage Fees to Expect in Canada

These mortgages come with arrangement costs and fees just like first mortgages:

• Application/Admin Fees – Up to $500
• Appraisal Fee – $200 to $500
• Legal Fees – $300 to $1000
• Title Search – $75 to $150
• Mortgage Insurance – 0.5% to 2.75% of the loan amount
• Early Payout Penalty – 3 months interest

Mortgage default insurance may be required if your down payment is less than 20%. Penalty fees usually only apply if you break a closed fixed rate term early.

Total fees will generally be a few thousand dollars. The exact costs depend on your lender, province, and final loan amount. Make sure to account for fees in your budget and request a detailed cost estimate from potential lenders.

Benefits of a Second Mortgage

These mortgages offer several potential benefits for homeowners:

Access Your Home Equity – Tap into the hard-earned equity in your property for major expenses and financial goals.

Lower Interest Rates – Rates are generally lower than unsecured loan options like personal loans or credit cards.

Maintain First Mortgage – Keep your current first mortgage terms and rate intact instead of refinancing.

Increase Cash Flow – Pay off high-interest debts and consolidate payments to improve monthly cash flow.

Make Home Improvements – Renovations and upgrades can improve living enjoyment and increase home value.

Buy Investment Properties – Leverage equity from your primary residence to purchase rental properties and build wealth.

Fund Education – Pay for yourself, your spouse, or your children’s post-secondary education costs.

Avoid Foreclosure – In some cases, this mortgage can provide cash to reinstate a mortgage in arrears and avoid power-of-sale.

Potential Risks of Getting a Second Mortgage

While second mortgages can open up valuable opportunities, there are also risks to weigh:

Higher Interest Rates – Even low second mortgage rates are higher than first mortgages and could rise over time.

Difficulty Qualifying – If your financial situation declines, you may fail to qualify for additional borrowing later.

Payments Stretch Budget – Adding a second mortgage payment to your existing mortgage and expenses.

Overusing Home Equity – Borrowing too much equity reduces your ownership stake in the home.

Second Lien Position – First mortgage gets paid if you default and the home is foreclosed on.

Prepayment Penalties – Breaking a closed fixed rate term early can incur fees and penalties.

Credit Score Impacts – High HELOC or second mortgage balances could negatively impact your credit score.

Loss of Home – Excessive borrowing through second mortgages risks losing your property if payments become unaffordable.

Before deciding if this type of mortgage is right for you, create a detailed budget accounting for the new payment. And avoid borrowing more than you realistically need.

Alternatives of Second Mortgages to Consider

In some cases, there may be more brilliant options than taking out a second mortgage, such as:

Cash-out Refinance

With a cash-out mortgage refinance, you replace your existing first mortgage with a new higher-balance mortgage. This lets you consolidate debts or access equity at a low rate in one single mortgage.

Personal Loans or Unsecured Line of Credit

Borrowing against your home equity should be a last resort. Personal loans or lines of credit could provide cheaper financing for minor borrowing needs.

Savings and Budgeting

See if you can build up savings for your goal rather than incurring the costs and risks of another loan. Also, look for areas to trim your current budget and redirect money to savings.

Sell Assets or Use Investments

Instead of borrowing against your home equity, you may be able to free up funds by selling other valuable assets, such as a car, boat, jewelry, antiques, or investments.

Explore All Options Before Deciding! Don’t jump into a second mortgage without thoroughly exploring alternatives like the above options. In many cases, there are smarter ways to access funds without further leveraging the equity in your home.

Second Mortgage Lenders

Where you get a second mortgage can significantly impact the loan terms, interest rates, and fees offered. Here are some options Canadian homeowners have:

Major Banks and Smaller Banks

While the Big 6 Banks in Canada all offer HELOCs, RBC and BMO are the only major banks offering home equity loans.

Many smaller lenders and banks offer second mortgages. 

Read more: The 15 Best Banks for Mortgages in Canada

Credit Unions

Local credit unions sometimes provide second mortgages and home equity loans, especially for existing members. Credit union rates may be competitive.

Private Lenders

Private lenders like mortgage investment corporations provide second mortgages outside the traditional banking system. They may have more flexible qualifying requirements but charge higher rates and fees.

Mortgage Brokers

An experienced mortgage broker can help you explore second mortgage options across multiple lenders and find competitive rates. Brokers have access to both bank and private lending channels.

When researching lenders, look for reasonable rates, flexible terms, and a seamless application process. Make sure to ask about all fees and costs associated with their mortgage products.

Is a Second Mortgage Right for You?

While second mortgages allow Canadian homeowners to leverage equity in their properties, this route does come with risks and expenses that require careful consideration.

Here are a few key questions to ask yourself when deciding if it is the right move:

• Will the money be used for an essential purpose that merits taking on more debt?
• Will the new payment fit comfortably within my existing budget?
• Am I borrowing more than I realistically need?
• Have I looked at alternatives like refinancing, budgeting, or other options?
• Am I comfortable with the increased risks of borrowing against my home?

If you’ve run the numbers and are aligned with the long-term benefits and costs, a second mortgage can be a viable way to access your home equity strategically. But pursue this strategy carefully and avoid unnecessarily over-leveraging your property’s equity.

Get Expert Mortgage Advice!

Our licensed mortgage professionals can help analyze your financial situation to determine if borrowing against your home equity makes sense, provide tailored rate comparisons, and guide you through every step of the application and approval process.

For tailored advice on navigating your mortgage options, contact Canada’s top mortgage advisors at Best Mortgage Online today!

FAQs

Article Sources

1. Getting a second mortgage
2. What is a Second Mortgage?
3. A Homeowner’s Guide to Second Mortgages in Canada