Second Mortgage – what is it, and how does it work?

What is a Second Mortgage?

A mortgage, whether a first mortgage or second mortgage is an interest in land created as a security for a loan that the lender would give to the borrower for purchasing real estate. Majority of the people who purchase real estate, are in fact buying a residential property to live in and get what we call a 1st Mortgage. The borrower completes a mortgage application in order that they can be approved for getting a loan to buy their home.

There are instances where due to different factors, an applicant cannot come up with the entire amount of the down payment to buy a house (real estate) and the lender would only give up to a certain percentage of the appraised value of the property to the borrower. To come up with the difference, the applicant looks for another lender who is willing to give a Second Mortgage (loan) in place of the missing down payment amount in order to allow the applicant to get the first mortgage.

The steps and qualifications of getting a second mortgage are in line with, and similar to getting approved for a first mortgage, except that the application process will be somewhat more strenuous on the applicant due to the fact that there is a higher risk involved. Therefore the lender, who most likely will be a ‘Private Lender will want to make sure that the applicant is capable of handling an increased debt load.

There could be several reasons as to why one would apply for a second mortgage, but two obvious and common ones are because of debt consolidation and maxing out on the exiting property’s equity for investment purposes.
If your first mortgage is with one of the large chartered banks, they will most likely not allow you to get a second mortgage behind them from anyone else. The alternative option would be to go back to the same bank that your first mortgage is with and see if there is enough room to refinance the property to get more money out of it, or to get approved for a HELOC (Home Equity Line of Credit). In either case, once approved, you will have access to extra cash that you can use for the purposes you need it for.

If going to your bank for refinancing or getting a HELOC is not an option, then the next thing you can consider to do is to refinance the mortgage with other lender types that will allow a second to come behind their first mortgage, which in most cases would be that you get your first mortgage with a Trust company sort of a lender and they usually allow you to get a second mortgage behind them through a private lender. Sometimes the first lender will offer their own second mortgage solution.

— Process & Qualification —

– If you have an existing mortgage, check with your current lender if they allow a second mortgage behind their first.

– In both cases, whether the answer to the above is a yes or a no, you must complete the mortgage application in order that it can be evaluated and analyzed to make sure your income to debt ratio is strong enough to handle both mortgages.

– An appraisal needs to be done on the property that the mortgages will be registered to, for the purpose of confirming its current market value.

– The first lender will then make the decision on whether to allow a second mortgage to come in behind it and what the total loan to value of the combined mortgages can be. For example, they would say that the first mortgage will be 70% of the appraised value, and they will allow a second to be set up to 15%, making the total loan amount 85% of the appraised property value.

The reason that the application process can be more strenuous and harder to get approved for the second mortgage is because usually the second mortgage comes with a high ‘price tag’, meaning a very high mortgage interest rate plus lender and broker fees. So when your debt ratio levels are being calculated not only is your first mortgage considered in the calculation but also the second mortgage must be added, which will have a much higher interest rate, plus all your existing debts. What is happening now is that your total debt level has increased by a whole lot, but most likely your income has still remained the same; so the total second mortgage that you could get approved for might not be as much as you would think you could get.

— Cons of getting a Second Mortgage —

– Very high interest rate

– Expensive lender and broker fees

– Short term solution

– You can be taken advantage of and need to be careful who you work with.
Another matter that you should consider is that most second mortgage lenders want to get their money back by the end of the year. You need to plan for the future and make sure that you would be able to pay them back, otherwise known as a exit strategy. The second mortgage lender could consider extending the loan to you, but again it will be at an expensive cost, or they may stick to their guns and demand that you pay them back, and if you can’t then things can start to get ugly legally and financially.

— Conclusion —

Whenever clients approach us about the idea of getting a second mortgage we try to guide them away from it, and only go that route if necessary and when there is absolutely no other option available.