Even with high interest rates and current uncertainty in the economy, Canadians are still confident in the value of buying a home. A recent report found that almost half of Canadians believe that a residential real estate purchase will perform the same or better than their other financial investments over the next year. 

 

While the desire to climb the property ladder remains strong, high borrowing costs and strict mortgage lending rules still pose a major barrier to many eager home buyers. Even with stabilizing home prices in some parts of Canada, most home buyers still need a higher income to qualify for a mortgage compared to a year ago. This is prompting home buyers to try and build up a larger down payment to give themselves a head start on their financing, and as a result, many are turning to parents or relatives for help. 

 

This is just one of several situations where a second mortgage could be a key tool for homeowners. In today’s turbulent housing market, homeowners will turn to their mortgage brokers now more than ever to come up with creative solutions to help them achieve their financial objectives. 

What is a second mortgage? 

 

A second mortgage is another loan that a homeowner can take out on an already-mortgaged property,  which leverages the equity they’ve built in their home as a source of funds. Private lenders typically offer second mortgages for a lower principal amount at a higher interest rate compared to a first mortgage, since they are riskier loans.  This is because, if a homeowner defaults on a home with two mortgages, the lender of a first mortgage would be paid out first. Banks and other traditional lenders generally do not offer second mortgages, except in the form of a revolving home equity line of credit, or HELOC.

 

With a second mortgage, it’s vital to discuss the pros and cons of this type of financing, as well as the importance of a sound exit strategy with clients, as this type of financing has its risks. Second mortgages are a short-term financing solution, often with a maximum 12-month term. In addition, the borrower is responsible for paying closing costs and other expenses (e.g., appraisal fees) associated with the second mortgage upfront.  

How can a homeowner benefit from a second mortgage?

 

A second mortgage can be a great tool for homeowners to access the equity in their home. Here are a few scenarios where it  could be the right move.

 

Funds for short-term needs

 

Life can throw curveballs—and sometimes, that means unexpected expenses. Homeowners could use a second mortgage to finance costs that they didn’t quite plan for on a quicker timeline. Private lenders like CMI require less documentation and can often approve a second mortgage in hours, compared to traditional lenders which could take several weeks to put a HELOC in place. 

 

For example, if the sale of a house is delayed, a homeowner may need “bridge financing” to provide funding and cover costs associated with buying their new home. In another case, if a homeowner overextends themselves financially causing them to lapse on their first mortgage payments, a second mortgage could be a lifeline to bring their primary mortgage up-to-date and stall a potential foreclosure. A homeowner could also use a second mortgage to finance other large purchases, such as university or college education, home renovations, a new vehicle, or the down payment on an investment home or their child’s first home. A second mortgage is also a valuable option to finance things that a traditional lender will not lend on, such as Canada Revenue Agency (CRA) tax arrears.

 

Refinance alternative

 

Particularly when interest rates are low or decreasing, a refinance is a great way for homeowners to access their equity. But when rates are high or rising, it may not be in a homeowner’s best interest to break their current mortgage, especially if it’s fixed at a lower rate and the loan isn’t up for renewal any time soon. In addition, the homeowner will likely have to pay a costly prepayment penalty fee for breaking the existing mortgage. 

 

A second mortgage is an alternative solution that allows homeowners to access their home equity without having to interfere with their first mortgage so that their current financing remains locked in at its current rate. A second mortgage can also help homeowners avoid those penalties, and private lenders like CMI can customize the maturity date so it comes up for renewal at the same time as their first mortgage. At that time, the two mortgages can be rolled together into one first mortgage.  

 

A second mortgage could also be a viable option for homeowners with bruised credit, as they won’t have to requalify for a refinance with their bank or traditional lender. CMI can work with these clients to take advantage of the equity they’ve built, while they work towards improving their credit and financial profile. 

 

HELOC alternative 

 

Homeowners with a home equity line of credit (HELOC) are likely on the hook for much higher monthly interest payments than they expected due to the interest rate hikes last year. In some cases, a bank or lender will give a borrower an option to take out a combined loan, which pairs their conventional mortgage with a revolving line of credit. This allows the homeowner to borrow up to 65% of the home’s value (out of the 80% that a homeowner can generally borrow) as a revolving line of credit, which gives the borrower some flexibility in borrowing and repaying the loan without having to reapply each time. Whether stand-alone or as part of a combined loan,  HELOCs are always offered at a variable interest rate, even when attached to a fixed-rate primary mortgage, and homeowners will have to qualify. 

 

In addition, the Office of the Superintendent of Financial Institutions (OFSI) has introduced new rules that target HELOCs to ensure that lenders and borrowers can stay on top of their obligations, specifically with these types of loans. The OSFI’s new rules, which come into effect in late 2023, require borrowers to pay back on the principal (instead of interest-only) if they owe more than 65% of their home’s value.  

 

If a homeowner is above this threshold, it could be advantageous to convert their HELOC into a second mortgage. Similarly, if a homeowner is unable to qualify for a HELOC, or if a revolving facility is not an appropriate or preferred solution based on the homeowner’s circumstances, a second mortgage could be an alternative worth exploring. 

 

Debt consolidation 

 

Even though second mortgages are more expensive than traditional mortgages, they generally have lower rates than credit cards or personal loans, which makes them a great debt consolidation tool. The average Annual Percentage Rate (APR) is around 20% for unpaid purchase balances in Canada, and if an individual has multiple credit cards or high-interest loans, it could be hard to keep track of payment deadlines and balances owed. A second mortgage can help homeowners save on interest and annual fees, access additional cash, and at the same time, repair their credit. It’s a valuable tool to leverage the equity in their home for easy access to credit at a lower rate—and wrap their monthly payments into one. In addition, private lenders like CMI are open to discussing more flexible repayment terms, such as interest-only payments or pre-paid options. 

 

We can help

 

There are a number of scenarios where a second mortgage could benefit a borrower. A second mortgage can help a homeowner fund the purchase of a second property, consolidate high interest revolving debt, or avoid steep penalties associated with refinancing an existing first mortgage. Whatever the need, CMI can help.

 

As your private lending partner, we can offer flexibility that’s simply not possible through banks and other traditional lenders. Reach out to us anytime to discuss a deal or for more information on how a private mortgage can help your clients.