Second mortgages aren’t for everyone so I’m going to highlight what I think are the top 10 things you should know about them to determine if one is right for you.
- Get the cash you need quick
A second mortgage is a great way to access any available equity quickly without having to break the terms you presently have in place for your first mortgage. This way you will avoid any potential payout penalties associated with that first mortgage.
- Types of second mortgages
Basically you can get a revolving home equity line of credit (HELOC) which is secured by a 2nd mortgage behind your first mortgage OR a 2nd mortgage which is a separate loan with a set payment amount registered against the property. The HELOC is limiting as it’s usually only available at up to 65% of your home value (some exceptions apply) less the amount owing on your first mortgage and comes with strict qualifying requirements. A 2nd mortgage loan can usually be advanced at up to 80% of your property value, again, less the amount owing on your first mortgage.
- Private lenders have easier qualifying guidelines
If you are having problems qualifying for a 2nd mortgage with the lender who presently holds your 1st mortgage or any other lender for that matter, you may want to go through a mortgage broker and have a look at what private lenders have to offer. As you are not dealing with a large rigid institution, private lenders tend to be more flexible when it comes to qualifying and will work with you to find a solution that works for both you and them. Keep in mind they lend on a smaller scale so while their qualifying guidelines and document requirements are a bit looser, they tend to be more selective about the property they use to secure the mortgage. Talk to a mortgage professional about how second mortgage lenders products are different than going through a typical first mortgage lender.
- Higher Rates and Fees
While the HELOC usually comes with favorable terms like interest only payments, an open term and a low variable interest rate, as mentioned above, they are restrictive in their loan-to-value and qualifying guidelines. Private second mortgage lenders on the other hand are more adaptable though as they would not be paid out first in the event of a sale or a default, they are essentially taking on a greater risk and as a result charge higher interest rates and upfront fees.
- Watch out for renewal fees and increased payout penalties
Private lenders usually consist of an individual or group of individuals lending their capital out in the form of real estate secured financing also known as mortgages. As private lenders are not a bank, they are not governed by the usual bank rules and can lend to higher loan-to-values, ask for less qualifying documentation and charge higher renewal and payout penalties at their discretion.
- Short term is best
I recommend only using a second mortgage as a short-term financing solution. Higher interest rates coupled with larger penalties and fees should propel you to find a less expensive financing solution if possible, though if you have no other options available to you, know exactly what you are getting into and find out what is necessary to avoid private lending next time. You may need to fix your credit or aggressively reduce your mortgage amount in order to build enough equity to eventually combine the 2 mortgages into only one at a good rate with a reasonable payment amount.
- When would taking a 2nd mortgage make sense?
Most importantly, there has to be sufficient equity in your home to support a 2nd mortgage as the “A” lenders will only allow you to refinance up to 80% of the homes present value. If you are in the first year or two of a closed fixed rate mortgage term there may be a large penalty involved in refinancing that first mortgage in order to access more equity. Conversely, if current interest rates are lower than the rate on your existing first mortgage, refinancing and increasing that 1st mortgage may be the best choice for you. I would ask your mortgage professional for some cost calculations that should help you with your decision on how to access that equity.
- One, Two, You
If you have a second mortgage on your home, you are third in line to benefit from any equity available once the property sells after paying all costs associated with the sale including any real estate fees. Your first mortgage holder gets their mortgage balance owing, then the second mortgage is paid out with you receiving the remainder. Second mortgage financing reduces the equity you have in your home and you should keep that in mind if you’re selling soon and want to maximize your profits earned.
- Who you know makes a big difference
If you’re looking for a Home Equity Line of Credit, visit your personal banker as well as a mortgage broker to explore the options available to you as not all HELOCs are the same. I mention this as some lenders have what is called a “bundled product” which allows you to access home equity a number of different ways under one umbrella. This could include lines of credit or various credit card accounts along with a mortgage. When it comes to private financing, who you know matters more than what you know. Access to multiple private lenders instead of just one or two optimizes the best solution for your financing needs and working with a mortgage professional who has experience with both private and second mortgage financing is a suggestion I would make.
- Have an exit strategy
It is usually the intention of a majority of homeowners to pay down their mortgage balances as quickly as possible and a second mortgage can only cause delays in reaching that goal. Before you commit to second mortgage financing, ensure you have an exit strategy planned in order to protect your assets. Work with your mortgage professional on a plan that either has you paying off the 2nd mortgage financing quickly or to have an eventual refinance solution in place to avoid the renewal of your second mortgage multiple times.