BY: JAY BRIJPAUL
A mortgage is a loan given in exchange for the title of a property. A first mortgage is called the legal mortgage and is the original loan you took to buy the home. A second mortgage is registered after the first and is considered an equitable mortgage. In the event of a default, the payment of the first mortgage is prioritized over the second. There is a greater risk for lenders who lend second mortgages and they will charge a higher interest rate. Second mortgages should be for a smaller amount and for a shorter term than the first because of higher interest rates.
Second mortgages can be used in debt consolidations. Consider John who has a car loan of $20,000, paying, $400 per month and credit cards bills of $10,000, paying $750 per month. In addition, John has his mortgage plus other expenses to pay. If John consolidates the two loans by taking a second mortgage of $30,000 at 11% against his home, his monthly payment will drop from $1,150 to about $300 per month.
Second mortgages can be used to improve the home such as finishing the basement and renting it out. Let’s assume that you borrow $40,000 at 11%, the monthly payment will be $392 per month. The average basement rents for $1,200 per month. Another benefit is that the value of the home will increase because of the improvements.
There are two kinds of second mortgages: one is a home equity line of credit (HELOC) and the other is a private second mortgage. The HELOC is from the same lender who has the first mortgage. It is a revolving line of credit with interest payment only. The interest rates on HELOC are relatively low compared to private second mortgages. The lender will be registering a HELOC if the home has enough equity, your credit is clean, and you are qualifying to carry the extra debt. If that is not possible, you can get a private second where those rules do not apply, and the interest rates are substantially higher.
HELOC can be arranged with your current lender. The lender will assess your financial capabilities and arrange for an appraisal to be done on the property. The final registration is done using a lawyer. With the HELOC, you can use the money anytime you need it and pay it back whenever you can. Most lenders would lend up to 65% of the value of the property. For example, if the property is worth $600,000 and there is a first mortgage of $300,000, the lender would give a HELOC of $90,000.
Some private second mortgagees lend up to 90% of the value of the home. There are fees such as lender’s fees, mortgage broker fees and lawyer fees associated with the mortgage. There are other fees such as renewal and discharge fees as well. With private mortgages, the cost of borrowing can be as high as 10%. Make sure you read the mortgage commitment thoroughly and agree to the terms before you sign. The terms are negotiable.
Second mortgages can be used to startup businesses, or to invest but should not be used to buy depreciating assets such as furniture or cars. The interest on the second mortgage is tax deductible if the money was used for investment. You can use it to pay off your loans and credit cards but be careful not to get back there and stockpile debt again.
The disadvantage of having a second mortgage is that your payments are calculated over 25 years and with the high-interest rate, you are only scraping the surface of the mortgage amount. Hopefully the price of the property increases, and you can then approach your first mortgagee to consolidate the two mortgages into one with low-interest rates.