A second mortgage through a private lender is an excellent tool to straighten out your finances and help you through difficulties like a power of sale. However, you’ll need to avoid some common pitfalls when you’re leveraging your home equity in this manner.
What is a Second Mortgage?
As the name suggests, a second mortgage gets attached to a home or property with an existing mortgage already in place. It’s an outstanding way for a homeowner to use the equity they’ve already built up. Of course, equity is defined as the amount of a property or home that has already been paid off.
A second mortgage is an excellent way to get the money to stop a power of sale or foreclosure. Homeowners can also use the funds for unexpected repairs or renovations. A private lender has a streamlined, fast application process, partially because they focus on equity rather than a credit history.
Do: Evaluate Your Financial Needs in Ontario
You stand your best chance of getting a second mortgage through a private lender when you start by clearly defining why you want the loan.
- For example, some people like the streamlined application process for a second mortgage when renovating a home. With the flexible lending criteria that focuses on equity, a homeowner can get the money to do a renovation with a good return, like a kitchen before they sell. For example, this blog highlights how a kitchen remodel will give you a 93.5% return on the resale market. It supplies what’s called a “move-in ready” factor that helps you sell your property.
- Remember that a second mortgage through a private lender has a higher interest rate than a more traditional loan. As of September 2024, the interest rate for a second mortgage from most private lenders is between 8% and 12%. Borrowers must also consider broker, legal, and lender fees, usually between 4% and 8% of the total loan amount.
Don’t: Overborrow Against Your Home
The Loan-to-Value Ratio (LTV) is an essential metric for one of these private loans, and it relies in part on your equity and a proper market appraisal It is the most important factor for a private lender. The LTV ratio is the percentage of the property’s value owed in mortgages.
Do some research to see if the property values in your area are set to decline. If they do, you should be aware you can wind up with negative equity if you overborrow against your home.
That occurs when the market value of any property is lower than the amount of the owed mortgages. Remember, over-borrowing can put a homeowner in a situation where they can default through things like a spike in interest rates or a job loss.
Do: Use Second Mortgage Funds Wisely
The money you get from a private second mortgage should be helpful. For example, the streamlined application process can get you the cash faster than a bank loan if you’re looking for an immediate emergency repair like a roof.
If you’re already having financial trouble with your mortgage and facing a power of sale, these funds can help. The money you get from a second mortgage from a private lender can stop a foreclosure or the more common power of sale. Your payments are usually interest only, but they can be applied to overdue mortgage payments, legal costs, and even late fees.
A second mortgage is a financial cushion to consolidate high-interest debts like credit cards. You can get flexible repayment schedules when you work with a private lender.
To use the funds properly, you should understand the most significant metric used to accept a private second mortgage. Remember that you’ll also need an exit strategy because these loans are temporary solutions.
Understand The Loan-to-Value (LTV) Ratio
The money you get through a second mortgage with a private lender is based on the Loan-to-Value (LTV) ratio. Most private lenders will go up to 75% LTV. If a property is appraised at a market value of $400,000 and the homeowner is applying for a $300,000 loan, the LTV in this scenario is 75%.
LTV = All existing mortgages, plus all proposed mortgages, are divided by the appraisal value.
Due diligence is critical when you’re taking out one of these loans.
Don’t: Ignore the Fine Print
That means you’ll need to read the fine print, including some other costs. These include legal expenses, lender fees, appraisal fees, and interest rates.
Remember, the Financial Services Regulatory Authority of Ontario (FSRA) provides a code of conduct for mortgage brokers who handle these loans.
Here’s some of the information you’ll want to keep in mind.
- As a borrower, you can expect the highest interest rate if the mortgage you request approaches the lender’s maximum LTV ratio.
- The fees for a second mortgage to a private lender can range from 4% to 8% of the total loan amount. They can include broker fees, legal fees, and lender fees.
You’ll also need to read the fine print if you’re using a second mortgage to stop a power of sale. For example, a borrower needs to understand that breaking the terms of a mortgage agreement involves more than missing payments in some scenarios. Failure to insure the property, pay the taxes, and purposefully damage it or use it for illegal activities is a breach of covenant. Those can also start the process moving forward.
These are just a few things that borrowers need to be aware of when looking for a private second mortgage. It’s always a good idea to consult with professionals in the industry who can help guide you and answer your questions.
