BY: JAY BRIJPAUL
Jacob and Andrea get $2,000 cash flow every month from their home. They took a home equity line of credit for $300,000 at 4% against their home and lent it as second mortgage at 13.75 %. Mary broke her GIC at 1.5% and invested in a private second mortgage that pays her 12%. Second mortgages are safe and secure if done correctly.
A second mortgage is a loan that is registered on the title of a property. It is called second mortgage or “junior” mortgage because the first mortgage is senior, and in the event of default, the first mortgagee gets paid first and then the second. Second mortgages have higher risks and higher rewards.
There are many reasons why people need second mortgages. With the new stress test, buyers will qualify for less mortgage and to make up the shortfall, they will resort to borrowing private funds. Others may need it because of their poor credit or being self- employed or to start a new business. The lender would give the borrower a lump sum amount and in return, the borrower would make regular monthly payments by electronic withdrawal or post-dated cheques to the lender.
Always assess your risk when lending. The first and second mortgages should not exceed 85% of the value of the property. If the borrower defaults, there is enough equity in the property to cover. Lend only on a principal residence and avoid lending to investors. Investors usually spread themselves thin and in the event of a price drop, the equity is depleted. If lending to investors, ask for a blanket second mortgage where the mortgage amount is registered on multiple properties. Before lending, make sure the home is marketable. It is better to lend on a home in Toronto then one in Thunder Bay. Avoid lending to owners with large expensive homes. Large expensive homes take longer to sell, and chances are the first mortgage and property taxes will be substantial.
The amount of the second mortgage should be between $25,000 and $50,000 to reduce the risk. If you have $100,000 to invest, then invest ins three properties instead of one. The first step is to let the borrower complete a mortgage application. Find out the reasons why the borrower needs the money. Get a credit search done and review the application along with the credit report carefully. Ask for a job letter, recent pay stubs and T4 slips for the past two years. If the borrower is self-employed, ask for the last two years tax return. The reason is to make sure that they are paying their taxes because that takes precedence over any mortgages.
You will need a lawyer to finish the transaction. Your lawyer will prepare the necessary mortgage documents, have the buyers sign, and then you. The money is given to your lawyer. In many instances, there are two lawyers involved, the borrower’s lawyer and the lender’s lawyer. All the costs involved, including your lawyer’s fees, are paid by the borrower. The term of the mortgage is usually for one year and can be extended if both parties agree. Always use your lawyer and not the borrower’s lawyer.
You can find second mortgages by placing ads or by contacting lawyers, mortgage brokers, and realtors. Many mortgage brokers would help for a fee, called a finder’s fee, which the borrower pays. Second mortgage holders sometimes sell their portfolios for a discount. For example, $40,000 mortgage at 13% can be sold for $35,000 at 13% because the mortgagee wants to cash out.
Many investors choose second mortgages because of low administrative costs and passive source of income. Money depreciates on a long-term basis and the best strategy is to invest in real estate in the early years to build equity and then use that equity to lend second mortgages.