Having a home under your name is truly a blessing, but to reach that status, people buy mortgages to buy homes. It is a very popular method of becoming a homeowner these days.
Mortgages are a simple process; you choose a house you like and you go to the mortgage lender. You send an application for the mortgage to be approved (meaning the lender will lend you the loan amount), and when it gets approved, you get a lump-sum amount up front to pay for the home. Over time, the borrower is then required to pay off the principal amount including interest to the lender.
The lender also keeps the house as collateral; meaning if the borrower were to default on the loan, the lender is well within his rights to sell the house and pay off the remaining loan. This is all part of the primary mortgage. There is a second mortgage too, let’s see what that is.
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Second Mortgage Definition
The primary mortgage which has been lent to you stays there; you have been given an amount which you have to pay with interest in monthly installments. Once you pay the whole loan, that is when you’re officially the owner of the loan.
What if you have another major expense that needs to be taken care of? Maybe a student loan debt or a wedding planned in the next couple of months? It is very much possible that you’re not given another loan because you haven’t paid off your primary mortgage yet.
That is when you have the option of a second mortgage- meaning borrowing against the equity of your home. A second mortgage helps homeowners get a smaller loan against their home equity- which is also known as the home equity loan.
Second mortgages are also to be repaid within a specific period of time, with an interest rate decided upon the beginning of the agreement. The second mortgage interest rate is relatively higher. This is because the borrower is likely to default on the second mortgage, because payment for the first one is the priority. And of course, the second mortgage has to be fully paid before another loan can be obtained against home equity.
Second Mortgage Example
How second mortgages work is fairly simple, but with all the math involved, it can be a little tough to understand. Here’s an example:
Chris has an auto loan. The balance is $10,000, with an interest rate of 9% and two years are left on the term. Consolidating that debt to a home equity loan at a rate of 4% with a term of five years would actually cost him more money if he took all five years to pay off the home equity loan.
And now, his home is collateral for the loan instead of his car. So if Chris defaults on the loan, he could lose the house which would be more dangerous than him losing his car.
That is how a second mortgage works.
Second Mortgage Requirements
Just a recap: if a borrower has a first and second mortgage, and they default on the loan, the first mortgage lender has the right to go after your house (collateral). This makes the job of second mortgage lender A LOT riskier.
So, a second mortgage lender has a stricter criteria as requirements too. Here is what is essentially required from the borrower:
- Equity: The second mortgage lender cares about equity- and lots of it. The borrower must have more than 20% equity on their home. They will probably hire an appraiser to calculate the exact amount of equity on your house. And that way you can see how much of a second mortgage loan you can borrow.
- Credit rating: Usually a good credit score is required for a second mortgage, usually 620. This will get you a competitive rate in the market and maybe a lower interest rate than usual.
- Debt-to-income ratio: This metric shows how much debt you already have against your monthly income, and mortgage lenders want it to be less than 43%. That is how you will qualify for a second mortgage.
Second Mortgage Lenders
Second mortgages are given out through three sources:
- Trust company
- Private mortgage lender
|Lender||Example Company||Product||Interest Rate||Credit Score||Minimum Equity|
|Major bank||TD Bank||Home equity line of credit||2.50%||650-900||25%|
|Trust company||Home Trust||Mortgage (in second position)||15.00%||550-700||10-15%|
|Private mortgage lender||Tridac Mortgage Corporation||Mortgage (in second position)||10.00%||Less than 600||10% or less|
Note: Sample rates have been extracted online, courtesy of RateHub.
Second Mortgage Loan Calculator
A second mortgage loan calculator is an online tool that tells borrowers how much they can borrow against their current home equity. It is always best to consider the numbers before approaching a second mortgage lender so you have an idea of what to expect.
How much loan you can borrow actually depends on how much credit rating you have, your DTI, income, home equity and several other factors. If you feel your current credentials are not enough for a bigger loan amount, you can take certain measures to improve it, such as:
- Bigger down payment
- Reducing debt even by a short percentage will help you
- Improve credit score by timely payments
How much you can borrow depends on your credentials and the calculator will give you an even better estimate of what you should expect. It is important to make sure to borrow only what you need, because you also have a primary mortgage on your shoulder.
And before you even begin to pay off the second mortgage, you will have to first get rid of the first one. So you’re actually looking for decades of debt and loan that needs to be paid. Make sure all your options are properly weighed down before you even look for another mortgage. Also, it is always better to shop around for the best rates and low interest so that your budget isn’t shook to the core.