What Is A Second Mortgage? And Why Do People Get Them?

Second Mortgage
Photo by Evan Dvorkin on Unsplash.

Plenty of consumers find themselves in need of a big chunk of change from time to time. Whether it’s to cover the cost of home renovations, a major car repair, or even to cover to cost of college or university tuition for their kids, sometimes there’s just not enough money in the pot to make specific payments in full.

That’s why loans exist. They make it possible for consumers to make big-ticket purchases without having to come up with all the funds all at once. Instead, they can gradually pay the loaned funds back in installments over time.

But while there are several types of loans out there for consumers to take advantage of, there’s a unique one that only homeowners are able to tap into: second mortgages.

What is a Second Mortgage?

As the name suggests, second mortgages take second place in line after first mortgages. A first mortgage is a primary loan that pays for a home. It takes precedence over any other liens on the title of a property in case the borrower defaults. A second mortgage, therefore, would be second in line behind the first mortgage.

Also referred to as a “home equity loan,” a second mortgage can be taken out in an effort to free up the money required to cover a large expense. If you have enough equity built up in your property, you may be eligible for this type of loan.

READ: 7 Things You Need To Know About Home Equity Lines Of Credit

Equity simply refers to how much of the value of the home you actually own. More specifically, equity is the market value of the home minus any outstanding debt still owed on the mortgage. Lenders who supply second mortgages typically require that homeowners have at least 80 per cent equity in their homes in order to qualify.

For instance, if your home is currently worth $700,000 and you still owe $400,000 on your mortgage, you would have $300,000 in equity ($700,000 – $300,000).

How Do You Qualify For a Second Mortgage?

While owning a home is an absolute must in order to borrow funds in the form of a second mortgage, there are other qualifications that you would have to meet. For starters, you’ll need to have at least 20 per cent equity built up in your home. That means you can borrow up to 80 per cent of your home’s appraised value.

In the example above, there would be about 57 per cent equity in the home ($300,000 ÷ $700,000). In this case, there’s enough equity in the home to be considered for a second mortgage.

You’ll also need to prove that your income, debt load, and credit score are up to par in order for the lender to approve you for a second mortgage.

Why Do Consumers Take Out Second Mortgages?

As mentioned earlier, second mortgages provide consumers – homeowners, more specifically – an opportunity to obtain extra funds needed to cover a large expense. That said, there may be other reasons for consumers to apply for a second mortgage.

For instance, a second mortgage can give homeowners an opportunity to consolidate their debt. If you have a number of debts, many of which come with high interest rates, a second mortgage may be able to be taken out to consolidate all that debt.

READ: 1 In 5 Canadians Will Liquidate Assets To Clear Debt This Year

In this case, the funds obtained from a second mortgage can be used to pay off all other debts. And if the rate that comes with the second mortgage is lower than your highest-interest debt, you’ll be able to save money. Plus, you can make managing your debt much more streamlined by eliminating several debts in favour of just one.

By consolidating your debt and making all debt payments on time every month, you may even be able to give your credit score a boost.

But perhaps one of the best reasons to take out a second mortgage is to pay for improvements on your home. Renovations tend to be rather expensive, but if you can use some of the money from your home’s equity, you’ll have enough money to cover the costs.

This is so beneficial because the upgrades can add value to your home. And, if you are careful about the type of renovation you do, you can effectively realize a high ROI on the project and add more value to your home than what it cost you in improvements.

Final Thoughts

Second mortgages can provide responsible homeowners with a great way to the borrow funds needed for a pressing expense. They can also be a great way to make improvements to homes that add to the property value. But remember, a second mortgage is still a loan. If you plan to take one out you should also make a plan for paying it back. If you’re in the market to take out a second mortgage, speak with a seasoned mortgage broker who can help you verify if you’re qualified for this type of loan and if this loan option is right for you.

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