Borrowing against your home sounds great. You get an automatic line of credit to buy those little extras you want or need. That sleek black stainless steel fridge you spotted on the Home Depot commercial. The 2011 Honda Civic with the low clicks from Autotrader.ca. Watch out! Easy money may not be easy to pay back.
How HELOCs Work
Second mortgages come in all kinds of packages. The most popular are HELOCs (home equity line of credits) that let you borrow against the day you sell your home and lump-sum amounts with fixed monthly payments. Unless a serious down market gets in your way, you can count on your home’s value going up. With a 20% down payment, you can borrow up to 80% of its market worth.
Calculating How Much Second Mortgage You Can Borrow
Say you have been paying on your first mortgage for several years and the balance owing looks like this:
- Appraised value of your home = $580,000
- You paid 20% down = $116,000
- Your bank can lend you up to 80% = $464,000
- Your balance on your first mortgage = $406,000
- Your available HELOC = $58,000
Up to $58,000 is available through your HELOC or a lump-sum second mortgage. When you sell your home, the mortgage lender pays off the first mortgage. Anything left over goes to pay down the second mortgage. If there’s a gap, you owe the rest.
Why Homeowner Credit Lines Are So Popular
HELOCs are popular with homeowners because you can borrow against them at any time, for any reason. Lenders like them because the more you borrow, the more profit they make. The risk you might default, especially with 20% down, is low. Just 0.09% of Ontario mortgages were in arrears in 2019.
Higher Interest, Extra Costs
Just in case you do default — the average Ontario homeowner has $22,671 in debts besides their mortgage — second mortgages come with higher interest rates . Unless your second mortgage is part of a total equity plan, you can expect to pay administrative fees for:
- title searches
- title insurance
- and legal costs.
On the bright side, second mortgages have lower interest rates than department store credit cards, which charge up to 29.9% annually. Second mortgages can be cheaper than an unsecured personal loan, but then consider what’s at risk: your home, credit score and peace of mind.
Losing Out on Interest Only
You go backwards when you make interest-only payments on your second mortgage or HELOC. Not paying down the principal simply keeps the credit line active. You give the lender your hard-earned cash, the lender makes money off the interest. Ultimately, you could pay as much or more in interest than the second mortgage itself.
What Can Go Wrong
Miss a few payments on your second mortgage due to COVID-19 or any financial disaster and your first mortgage may be at risk. As a last resort, the lender may seize your home, sell it and pay off both mortgages. Once your mortgage lender starts an action to collect the delinquent payment, there goes your fair to great credit score. Other lenders checking your credit rating may refuse you new credit.
Using Second Mortgages for Renos, Repairs
That’s not to say second mortgages and HELOCs don’t have their place. Renovating a fixer upper in a buyer’s market could be a good use of a second mortgage. Provided you catch a real estate upswing, you can pay the HELOC back when you flip the house. Using it to mop up rainwater from a wind-damaged roof also makes sense. You can use the insurance settlement to refund your withdrawal. But if you need the HELOC to pay day-to-day expenses, re-evaluate if you can afford your home and where you can cut back.
Where to Get Second Mortgages
Your regular bank or a mortgage broker can line you up with a second mortgage or HELOC. A lower credit score (600 or less) or low home equity, such as 10% down, puts you in trust company or private mortgage lender territory.
What You Need to Qualify for a Second Mortgage
Lenders look at your down payment — your equity is your share of the risk if you default. Keeping payments like utilities, Internet service and property insurance up to date is important, since that shows up on your credit score. Most lenders ask for a letter of employment or several recent pay stubs to confirm your income. An independent home appraisal or annual property assessment can confirm your home’s market worth.
Alternatives to Borrowing From Yourself
If borrowing against your home sounds precarious, it can be. Other ways to get the things you want:
- Pay down debts before you invest.
- Make your own fun by staying home more often.
- Spend less by going green.
- Buy a right-sized home, not a monster home.
- Save for big ticket items like appliances.
- Make renos over several years.
- Take in renters or get a second job.
- Borrow from your inheritance.
- Ask a family member for money.
Ontario’s Flat Fee Real Estate Lawyers
Axess Law Ontario real estate lawyers advise you on the ups and downs of second mortgages when you buy a home. Video calls and e-signing real estate closing appointments are available anywhere in Ontario, 7 days a week, day or evening. You can meet in person with our licensed lawyers at our Toronto, Scarborough, Vaughan, Etobicoke, Ottawa, Mississauga Winston Churchill or Mississauga Heartland law offices. Make an appointment by dialing toll free to 1-877-552-9377 or 647-479-0118 in Toronto or use our online booking form.
Click here to learn more about Axess Law’s real estate law services.