How Does a Home Equity Loan Work?

More than two million people in Canada apply for second mortgages but don’t understand it fully. Homebuyers need to understand how a home equity loan or a second mortgage works. Besides, there are advantages alongside disadvantages of this type of loan. We shall discuss the term in detail to aid you in understanding how it works. Without further ado, let’s start our discussion: 

What Is a Second Mortgage?

The primary mortgage is the first loan homebuyers take to purchase a house. Nevertheless, homebuyers acquire the second mortgage for the same property for which they take the primary mortgage. You can get a second mortgage even when you haven’t paid your primary mortgage fully. Additionally, the loanable amount is contingent on the home equity that homebuyers create via their primary mortgages. You have more chances of getting a second mortgage if you have more home equity. Besides, you increase your home equity while regularly paying your mortgage payments. So, Should You Get a Second Mortgage If You Qualify for It? 

Reasons You May Get a Second Mortgage

You can get a second mortgage for various reasons. You have the following reasons to acquire a second mortgage if you qualify for a home equity loan:

  • To use the amount as an emergency fund
  •  To capitalize on the investment opportunity
  • To pay for your child’s tuition fee
  • To clear high-interest credit card debt
  • To pay for home revamping in order to increase the value of the house
  • To pay for medical expenses
  • To consolidate debt
  • To invest in a car
  • To pay for wedding expenses
  • To pay down tax arrears and mortgage

Benefits of Getting a Second Mortgage

Getting a second mortgage can offer various advantages. Typically, you may get it to cover your immediate expense. Here are the benefits you may get if you acquire it from the lender:

  1. Low-Interest Rate: A reduced interest rate in contrast to rates that credit cards/car lease payments/unsecured credit lines offer
  2. A Better Credit Score: Improve in credit score if you utilize the loan for debt consolidation.
  3. Flexible Payment Terms: A second mortgage also benefits borrowers with more flexible payment terms.
  4. Options: You may get the option only to  pay the interest and make lower monthly payments
  5. Avoiding CMHC Fees: You may avoid paying CMHC fees.
  6. Investment: You may invest the money you get in a rental property to convert loan interest to a tax deduction. 

Disadvantages of a Second Mortgage

In addition to advantages, getting a  second mortgage has disadvantages. Mainly, you have a risk of losing your home from the lender if you default on paying your loan. Moreover, the following are also disadvantages of a second mortgage:

  1. You will need to pay the penalty if you miss any payments or pay your payments late. Thus, borrowers should try getting a second mortgage with reasonable or little penalties.
  2. You will need to pay additional appraisal costs, original fees, and credit check fees.
  3. Amortisations may extend to more than two decades contingent on a loan’s structure.
  4. Interest rates are higher as compared to a primary mortgage

How to Know If You Qualify for a Second Mortgage

You can qualify for a second mortgage if you meet the specific criteria lenders set to grant it. Here is how a lender may check your eligibility for a second mortgage:

  1. Looking at your credit score
  2. Considering your home equity
  3. Checking your financial status 

A lender will grant the loan if you have a good credit score, sufficient home equity, and good financial status.

Conclusion

Many homebuyers in Canada who acquire a second mortgage don’t completely understand how a home equity loan works. Typically, people acquire a second mortgage to pay off the immediate expense. Getting a second mortgage has advantages as well as disadvantages. Thus, homebuyers should consult with a reputable mortgage broker like Patrick Romann first to know if they should acquire it.

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By Cary Grant

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