Second Mortgage
This debt relief option involves taking out a second mortgage on your home to pay off your debts. This second mortgage is usually obtained from a different financing company than the one you have your existing mortgage with. Some people consider a Home Equity Line of Credit (HELOC) to be a type of second mortgage. However, a typical second mortgage usually takes the form of a loan that you pay back in fixed monthly instalments. A licensed mortgage broker
will help you find a lender who specializes in these types of smaller mortgages.How it works
With a second mortgage, you would take out a loan using the equity in your home (the difference between your home’s value and the amount owing on your mortgage) as collateral. It is different from a regular loan because it is secured to the value of your house, meaning that if you default on payments, you could lose your home. For this reason, it usually carries better interest rates than unsecured types of credit.
The interest rate for a second mortgage will generally be higher than the interest rate of your first mortgage, because the lender has to take on more risk. This is because if a homeowner defaults on any of the mortgage payments, and the home needs to be foreclosed, the first mortgage lender will always get priority to be paid out first, regardless of which mortgage payments the homeowner defaulted on. However, the annual interest rate on your second mortgage should still be much lower than the interest rates of the debts that you are paying off, often ranging between 5 to 12%.
When to get a second mortgage
A second mortgage is often used to pay out smaller debt amounts, as the fees associated with it are usually lower than those involved with refinancing your home. It can also be a good alternative if you are in the middle of your mortgage term, and would incur financial penalties for breaking your mortgage early if you refinanced; or if you have poor credit and would not qualify for refinancing.
One of the advantages of taking out a second mortgage, as opposed to other debt repayment options, is that you get to choose what types of debts you pay off with the funds. This is because the lender is giving you the funds directly to pay off your debts. This is different from other options such as refinancing your home, where the lender pays off your creditors for you, and are more selective about which debts they will include.
Although the purpose of a second mortgage is usually for debt repayment and repairing credit, it can also be used for other purposes such as home repairs and education.
How to qualify
The amount that you can borrow on your second mortgage is typically based on a loan to value (LTV) ratio of 80%. This means that the total amount of both your first and second mortgages combined can be up to 80% of your home’s total appraised value. So, if your home is worth $500,000, and the amount owed on your original mortgage is currently $380,000, then the total value of your second mortgage cannot exceed $20,000 ($380,000 + $20,000 = $400,000).
Other factors that will determine your qualifications for taking out a second mortgage are your income and credit score. Most lenders require a minimum credit score of 650.
There are some lenders, mainly private, who will offer second mortgages even if your credit score is less than “good”. However, these loans are usually offered at very high interest rates, and therefore should only be used for short-terms (e.g. one year) to bring up your credit score. A qualified licensed mortgage broker can review your situation thoroughly to help you find a credible mortgage lender, and let you know if this home equity product makes the most sense for you.
Impact on credit rating
Taking out a second mortgage has the potential to improve your credit ratings and credit score in a short period of time, because you will be paying off your existing debt right away. Therefore, any accounts that were negatively reported on your credit bureau reports will be reflected as paid in full status once paid out.
A second mortgage can also positively impact your credit score because the regular monthly payments on it will be reported to the credit bureaus. As long as consistent, on-time payments are maintained, there is usually no negative impact on your credit report or credit score from taking out a second mortgage. If you would like to improve your credit score or credit rating, check out our Tips for Rebuilding Your Credit.
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