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Second mortgages in Canada: 6 reasons you may need one

We’re living in a world where certain financial obligations must be settled on time. It could be college tuition, renovation costs, emergency repair bills, debt consolidation or even paying for a wedding. Whatever it is, it can’t wait, and it needs to be resolved as soon as possible.

As the saying goes, time waits for no one. And, neither do the bills lurking around the corner.

So what are your options? You may think of getting another credit card, but you’re past the limit or have a poor credit score. Traditional lenders have turned you down too, and you couldn’t be more disappointed.

However, if you’re a Canadian currently paying for a primary mortgage, you could have an ace in the hole to sort out your financial hurdles. This is where a second mortgage comes in.

What are second mortgages?

A second mortgage is a secondary loan held on top of your current mortgage. A different mortgage lender will typically provide this product. It’s important to note that second mortgages have their own rates and terms, and is paid independently of your primary mortgage.

In layman’s terms, second mortgages are loans that are secured by your home equity. Usually, you can acquire up to 80 percent of your home equity through a second mortgage and if you’re in a major city, up to a maximum of 85 percent.

In contrast to the primary mortgage, a second mortgage has its own terms and conditions. Hence, the second mortgage is paid separately with different rates from the first mortgage. Nonetheless, in case of a default, the second mortgage will only be repaid after the primary mortgage has been sorted out.

So what are some of the reasons you may need a second mortgage?

1. You want to pay off high-interest consumer debt

A recent report released by Statistics Canada shows that for every dollar of disposable income, Canadians owe $1.68 in credit market debt. In fact, Statistics Canada estimates that the accumulated consumer credit is $627.5 billion; not including mortgages. If you’re an average working Canadian, it is very likely that you have consumer debt.

Keep in mind that the average credit card interest rate in Canada is 19.99 percent. Of course, the longer you delay the payment, the more you keep paying higher interest rates. No wonder, most Canadians prefer low-interest credit cards.

However, there is another option. Even though the interest rate of a second mortgage is higher than the primary mortgage, it is lower than the accrued interest on credit cards and personal loans. A minimum payment of a second mortgage can be much lower than that of a credit, creating better cash flow for the borrower.

That means you can acquire a second mortgage to pay off high-interest consumer debt and save a lot of money in the long-run.

2. You have a poor credit score

According to the Huffington Post, the average Canadian credit score is 600 points. If you’re a Canadian, anything below 650 points is considered a bad credit score and you will probably find it challenging to obtain new credit.

Maybe it was that single loan that you defaulted for a month or that credit card charge-off—as long as you have a poor credit score, you will likely be the last in line when applying for loans.

The good news is that you can get a second mortgage even with a poor credit score. The lender can overlook the poor credit score based on your consistency on paying the primary mortgage and if you have a lot of home equity, albeit the interest rate will be higher due to the risk involved.

If you can pay off bad credit loans and defaulted debts by leveraging a second mortgage, you can start to repair your credit.

3. You’ve been turned down by traditional lenders

You never know when mortgage rules will change. Since the recent strict new rules on mortgage lending, more Canadians have been turned down by traditional lenders. In fact, mortgage brokers reckon that the rejection rate has increased by 20 percent. Even those who were approved for a mortgage before 2018 can have their mortgage renewal or refinance request turned down due to the stress test.

So what should you do if you’ve been turned down by traditional lenders? Simple; apply for second mortgages offered by private lenders. Unlike traditional banks, private lenders don’t have their hands tied down by the new OSFI rules.

4. You need funds quickly

There are many reasons why you would need quick funds. Perhaps you’ve experienced an unexpected tragedy or looking for a new job, and you need quick cash until you’re back on your feet.

You could go for an unsecured loan, but you don’t want to end up paying high-interest rates. Payday loans are even worse, the fees and interest rates are exaggerated. Even if you did get a payday loan, the credit limit is $1500, and you probably need more than that.

What about RRSP withdrawal? Well, you will get penalty taxes for making that early withdrawal. For instance, if you withdraw $30,000, you will only receive $21,000 after the bank remits $9000, or 30 percent, to the government.

On the other hand, second mortgages will give you liquidity to your home equity without too much interest rates or taxes especially if the amortization is short-term.

5. You want to avoid high mortgage penalties

Prepaying the remaining balance of a closed low fixed rate mortgage loan can be expensive for Canadians. Most lenders will impose a breakage fee if you decide to walk out of the contract before the term expires. Sometimes, the mortgage lenders can overestimate the liability and proceed to double or triple the penalties, leaving you in a tight spot.

Nevertheless, instead of pre-paying the first mortgage early and selling the house to gain funds for investment capital or debt relief, you could apply for a second mortgage to access the funds and wait a little longer. A short-term second mortgage would prove to be cheaper than paying the high mortgage penalties.

6. You want to outsmart PMI

Canadians who can’t afford 20 percent down payment of the property’s value when applying for a mortgage are required to pay private mortgage insurance (PMI). There are also borrowers who don’t want to give out the 20 percent down payment so they can have funds for renovation and repairs. Even so, PMI premium rates aren’t cheap especially if you’re putting up 5% to 9.99% down payment.

But did you know taking a second mortgage could lower the overall mortgage expenses than going the PMI route? Despite second mortgages having higher annual payments than first mortgages, they cost less than PMI.

Consult a professional to find a convenient second mortgage

As much as applying for a second mortgage seems like a straightforward process, finding a second mortgage without professional assistance is like climbing a slippery mountain without a harness.

Every situation is different, and there are always details in the contracts that you need to understand clearly.

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OSFI to take new measures to address equity-based mortgage loans

The federal regulator plans to address uninsured mortgages granted only on the equity of the property and loans where the lender didn’t apply other ‘prudent underwriting principles’

OSFI is taking measures to tighten the scrutiny of mortgage lending practices.THE CANADIAN PRESS/Sean Kilpatrick

A federal regulator says it will have to take further action to address mortgage approvals by Canadian banks that still depend too much on the amount of equity in a home, and not enough on whether loans can actually be paid back.

The Office of the Superintendent of Financial Institutions telegraphed the move in an update released Monday on the effectiveness of new underwriting rules it announced last year. Those rules included a new “stress test” for uninsured mortgages, where a borrower makes a down payment of 20 per cent or more.

According to OSFI’s October newsletter, the tweaks were needed after the regulator identified possible trouble spots caused by high levels of household debt and “imbalances” in some real estate markets that could have added more risk for banks.

There have been improvements in the quality of new mortgage loans since the revised B-20 guidelines came into effect this past January, OSFI says, “including higher average credit scores and lower average loan-to-value at mortgage origination.”

But even though OSFI said the new rules “are having the desired effect of helping to keep Canada’s financial system strong and resilient,” the regulator claims more work is needed.

“Although reduced, there continues to be evidence of mortgage approvals that over rely on the equity in the property (at the expense of assessing the borrower’s ability to repay the loan),” the newsletter said. “OSFI will be taking steps to ensure this sort of equity lending ceases.”

OSFI spokeswoman Annik Faucher told the Financial Post in an email that the regulator was referring to uninsured mortgages that were granted based only on the equity of the property — the difference between a property’s value and the amount remaining on a borrower’s mortgage for the property — as well as loans where the lender did not necessarily apply the other “prudent underwriting principles” laid out in the B-20 guideline, such as those aimed at proper documentation of income.

“Sound underwriting helps protect lenders and borrowers and supports financial system resilience,” Faucher said. “Having a larger amount of equity in a property does not mean sound underwriting practices and borrower due diligence do not apply.”

She added that OSFI “has a number of tools in its supervisory toolkit, and when we identify potential issues, we intervene and require financial institutions to implement remedial measures that are commensurate to the risk profile of the institution.”

OSFI said in its October newsletter that there are signs “that fewer mortgages are being approved for highly indebted or over-leveraged individuals.” According to the regulator, the amount of uninsured mortgage originations with loan amounts greater than 4.5 times the borrower’s income has dropped from 20 per cent from April to July of 2017 to 14 per cent for the same period of 2018.

In general, the Canadian housing market has cooled following intervention by regulators and various governments. But OSFI also said it realizes that its tighter underwriting rules might cause some would-be homeowners to use less-than-truthful means to obtain mortgages.

“OSFI recognizes that tightened underwriting standards may increase the incentive for some borrowers to misrepresent their income, while it has also become easier to create authentic-looking false documents,” the newsletter said. “Given that the revised B-20 calls for more consistent application of income verification processes, financial institutions need to be even more vigilant in their efforts to detect and prevent income misrepresentation. This is particularly important for financial institutions that depend on third-party distribution channels.”

Source: Financial Post – Geoff Zochodne October 9, 2018

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