Choosing a second mortgage from a private lender over refinancing with a bank has advantages. It’s an excellent way for homeowners in Ontario to access the equity they’ve built up without replacing an existing mortgage.
Understanding Second Mortgages
Second mortgages are loans that are taken out on properties that already have a primary mortgage. Like a primary mortgage, these loans are secured against the equity you’ve built in a property.
Equity refers to the difference between a property’s current market value and the total outstanding debts secured against it, including mortgages and any liens. It is not limited to the portion of the property that is fully paid off or “mortgage-free.” For example, if a home is valued at $500,000 and the remaining mortgage balance is $300,000, the homeowner’s equity is $200,000. Understanding equity in this way is essential when considering private loans, refinancing, or other financial decisions related to homeownership.
Getting a second mortgage through a private lender has some advantages. These are excellent for people who need a debt consolidation loan to pay off high-interest loans like credit cards. The process with a private loan is more streamlined, and the requirements are more flexible than with a traditional bank.
That means one of these loans is a good idea for repairing or improving a home, such as making energy-efficient kitchen upgrades.
Comparing Costs
The costs can increase if you are looking to refinance through a bank. Remember, banks need a stable income, including a letter from your employer and several years of T4 slips.
Homeowners can get quicker approval if they have equity in their property and don’t mind paying a higher interest rate with a second mortgage through a private lender.
Private lenders have more flexible and faster processes and terms. It’s important for anyone applying to remember that even though the interest rates are higher, the loan terms are shorter with a private second mortgage.
Flexibility in Use
A private lender has more lenient criteria, which makes them more willing to give second mortgages, especially to people who might not meet the higher benchmarks of credit unions and traditional banks.
Refinancing can also reset the entire amortization for the mortgage. A second mortgage through a private lender keeps the current state of the original mortgage intact. These loans are generally interest-only and for only one year terms with a private lender.
They suggest that people looking to take one out have an exit strategy. A second mortgage from one of these lenders is a stopgap to help you regroup and fix your finances.
Access to Equity
Traditional loans have stricter lending criteria, like a decent credit score. Equifax highlights a score of 670 to 739 as good. A score of 300 to 579 is defined as a poor score, and a borrower is not likely to get approved.
However, a second mortgage through a private lender uses different criteria. People with bad credit can get a loan by accessing their equity. These lenders use the Loan-to-Value (LTV) ratio, which places a big emphasis on the market value and equity. The more equity you’ve built up, the lower the LTV ratio and the lower the lender‘s risk. Equity is the part of the property that’s mortgage free.
Most private lenders will loan up to 75% LTV. Here is a quick overview of the formula.
A home is appraised at $400,000. Applying for a loan of $300,000 results in an LTV of 75%.
LTV = Total Loan Amount / Appraised Value of the Property.
One of the big advantages of a second mortgage over refinancing is that homeowners can access their equity without the need to modify an existing mortgage. Equity is calculated as the market value of the property minus all outstanding debts secured against it, not just the paid-off portion. However, they need to keep in mind that this second mortgage uses their home as collateral.
Potential Risks and Considerations
Remember that refinancing usually replaces an existing mortgage with a brand-new product with different terms. A second mortgage through a private lender is a loan taken out, and your home equity is used as collateral. These second mortgages are in addition to any existing ones. You’ll need to pay higher interest rates with one of these from a private lender since there’s usually a higher risk.
Quick Access To Money
They allow people to access the equity they’ve built up without needing to modify an existing mortgage loan. This is a good option for people who need quick access to cash, might have a low credit score, but don’t want to refinance the entire loan.
One of the other things to consider when you’re choosing between the two is the closing costs. While some of these costs are the same, a private loan can usually waive credit check fees because they look at the equity you’ve built up. Don’t forget that equity is defined as the amount of mortgage-free property.
Mortgage insurance is required on a traditional refinance if the down payment is less than 20 percent. That’s not the case with private loans because they are equity-based and not credit-based. Mortgage insurance is required if the LTV exceeds 80%, which applies to both initial mortgages and refinances, not just the down payment scenario.
