A 2nd mortgage? Yes, this option can save you money.

Quick, what’s the first thing that comes to mind when you think of “second mortgages”?   For some it could be that shady looking character in a smoke-filled pool hall… guys with gold chains and a baseball bat nearby.   Maybe you’re thinking of someone in financial trouble. Or maybe it’s just someone who doesn’t want to pay outrageous costs and penalties to refinance their existing mortgage.

The mere mention of 2nd mortgages conjures up all sort of images.  Most of them, negative.  For many, a 2nd mortgage can be a last resort solution during a financial crisis.   For several others, it can be an opportunity to save money.   That’s right, to save money.

Sure, 2nd mortgages carry a higher interest rate than 1st mortgages but, they can also serve a purpose.    One of those purposes can be to save you money.  Yup, I said it again.  There are some new trends emerging with today’s new mortgage products that are forcing consumers to seek other options.  Two of these trends are INFLATED PREPAYMENT PENALTIES and NO FRILLS MORTGAGES!

I’ve written extensively about the unfair prepayment penalty calculations used by all the BIG SIX BANKS.   With interest rate discounts being higher than ever (around 2.00% off posted 5 yr fixed rate), we have also seen ridiculously high prepayment penalties. We’re talking about 14, 16, and 18 months worth of interest penalty being charged to unsuspecting consumers.  That’s $20,000, $30,000 and even $35,000 in mortgage prepayment penalties.  Remember, this isn’t some obscure bank or small Lender, it’s the BIG SIX BANKS.

HERE’S ONE EXAMPLE OF HOW A 2ND MORTGAGE HELPED THESE CLIENTS SAVE.

SITUATION…Recently, a couple contacted me for help.  They needed to borrow $40,000 to pay for some home repairs and renovations.   They had a 1st mortgage with a major bank with an interest rate of 3.19% and 3 yrs remaining in their term.  They couldn’t refinance it with the Bank because the new mortgage rules won’t allow you to refinance a 1st mortgage above 80% of the appraised value (thank you Jim Flaherty, former Federal Finance Minister for that change).  Second mortgages are available up to 95% of the house value. 

OPTIONS…. well, there really was just one.

In this case, the home was worth around $830k and the current mortgage had $650k owing.   But their Bank wanted to charge them a $26,000 penalty to payout their current mortgage.   Now, if that number doesn’t bother you, let’s put it another way.  That penalty works out to a 15 month interest penalty charge.  Incredible and outrageous, isn’t it? (side note:  there are several other Lenders with equal or better rates that would only charge a 4 or 5 month interest penalty for this same mortgage situation.  That could save the client between $19,000 and $20,000)

We ended up getting this client a $45,000 mortgage with payments of $488/mth and it didn’t cost them $26,000 in penalties or fees like the Bank wanted.  And when their 1st mortgage comes up for renewal in 3 yrs, we will combine both mortgages into one new first mortgage…. and we won’t be going to a BANK that has those inflated prepayment penalty calculations.  

NO FRILLS MORTGAGE (OR LOW-RATE MORTGAGE, AS SOME CALL IT) FORCES $62,000 IN FEES AND PENALTIES OR A SECOND MORTGAGE!

Here’s another growing reason why 2nd mortgage volumes are increasing.  ‘Just get the lowest rate possible’….I’ve actually seen a lot of Banks and brokers promote this strategy without regard for the terms in the mortgage.  That’s a dangerous strategy to take….please read on as this example may sound familiar to some of you.

One of the more well-known products today is, BMO’s low-rate mortgage.  Clever marketing.  They advertise a rate that is slightly lower than the rest of the BIG SIX BANKS yet they don’t seem to focus on the product limitations (of course, they don’t tell you your mortgage broker will usually get you better rates and always get you better terms).   We won’t go over all those limitations here but, we will focus on one.  Not being able to refinance the mortgage with another Lender.  That’s right, you cannot pay out your mortgage prior to the renewal date unless you sell your home.

I had a client come to me with a BMO low-rate mortgage.  They ran into some financial difficulties.  They own a house worth $600k with a $400k BMO low-rate mortgage (this is a NO FRILLS mortgage).  The rate is 3.29% with 3 yrs remaining.    They had some bad luck.  The transmission on their 8-year-old car will cost $6,000 to replace.  Not worth the repair.  They need a newer car (stay away from brand new cars… buy a 1 or 2 yr old vehicles and save a 30% to 40%).  They also need to do some repairs and renos on their home.   Last year, they had inconsistent income due to lower bonus income.   It affected their ability to pay some bills on time.  They approached BMO for a $50k mortgage increase.   BMO had to decline them due to their lower credit scores.   But they also can’t payout the BMO low-rate mortgage because they are in their NO FRILLS mortgage.   The only way to get out of the BMO mortgage is to sell the home.

OPTIONS…   sell the house and buy a slightly lower priced home for $550k

This will free up your equity to pay your bills… however, you will have to pay $30k realty fees, $1500 in lawyer fees and $7400 in Land Transfer Tax (amount depends on province.. to my friends out west that don’t have LTT.. I’m envious!!) And if you’re in the city of Toronto, you face an additional Toronto Land Transfer Tax of $6700. That’s around $38,000 to $45,000 in property disposal costs!!!!  And we haven’t factored in the BMO mortgage penalty… that’s gonna be another $17,000!  Grand total is $62,000 in fees and penalties.

OR… keep the house and get a second mortgage.

We got this client a $55,000 second mortgage with payments of $595/mth.    They kept their home, got a new car, did the small renos that were needed in the house and are working to pay back this mortgage.   Once their 1st mortgage comes up for renewal, they will be seeking my help to combine the 1st and 2nd mortgage into one new 1st mortgage… and to get away from the NO FRILLS mortgage.

MORE EXAMPLES OF WHEN A 2ND MORTGAGE CAN MAKE SENSE.

In most cases, a 2nd mortgage can make sense when you can no longer qualify for a higher mortgage with your current Lender or the penalties are so high that it’s cost prohibitive.   Or, as mentioned above, your Lender won’t allow you to leave.   Here are some more reasons:

• medial emergency…. treatment costs can be extremely expensive and your health insurance may not cover such claims.
• business trouble or failure.
• loss of employment or reduced income.
• new mortgage rules won’t permit you to borrow over 80% loan to value..  a 2nd mortgage could bridge that gap.
• borrow to invest.
• employee share purchase..
• fund home renos to attract a higher selling price.
• pay for a child’s University education.
• you have a 1st mortgage, and 2nd line of credit and need more money.  You will have to pay off the 2nd line of credit with a new, larger 2nd mortgage.
• buy and investment property.
• 2nd mortgages are available up to 95% of the appraised value of the home. 

Second mortgage rates can vary.  You need to consult a broker prior to considering a 2nd mortgage.    Second mortgage Lenders will reduce their loan amount or won’t go behind a collateral 1st mortgage or secured line of credit.  That’s because these type of mortgages are not amortized.  This means they can  be paid down and go back up.    TD Canada Trust and ING are registering all their mortgages as collateral charges.   Scotiabank is rumored to be making a change to register all their mortgages as collateral charges also.  Here’s some advice… stay away from collateral charges.   You will find it difficult to borrow a 2nd mortgage probably more importantly, you will have limitations when it comes renewal time as collateral mortgages are not accepted for transfers.  This reduces your negotiating power at renewal time.

Your best interest is my only interest.   I reply to all questions and I welcome your comments.  Like this article?  Share with a friend.

Steve Garganis 416 224 0114 steve@mortgagenow.ca