Is a second mortgage a good idea?

Updated: Sep 11, 2024

In certain situations, taking out a second mortgage may be a good idea for you – if you qualify for it. While a second mortgage is typically seen as just another long-term financial burden, this can offer concrete benefits. Used properly, a second mortgage can fund home renovations, consolidate debts, and fund the purchase of an investment property or other investments.

With home prices at unprecedented highs, and with higher interest rates and construction costs, it may seem like it’s not a good time to take out a second mortgage to buy another house in Canada. And despite lower sales, home prices continue to rise, which is bad news for potential home buyers.

It may yet be a strategic financial move for you to take on a second mortgage if the conditions are right and you have a good reason to do so. In this article, Mortgage Professional gives advice on the question: is a second mortgage a good idea?

If you are on the fence about taking a second mortgage in Canada, here are some things you should know.

What is a second mortgage?

A second mortgage is a loan that you take out on a home in addition to the original mortgage on that home. Since a second mortgage has a different status, the interest on second mortgages is typically more expensive than the original mortgage rate.

The reason why second mortgage rates are higher is that the first mortgage must be paid out first—before the second registered mortgage—if you default on the mortgage.

The second mortgage is money you borrow against the accumulated equity in your home. This equity you borrow against for the second mortgage represents the amount of the home you own outright, as opposed to the amount you still owe.

Simply put, the equity is the difference between the value of your home and the remaining balance on your first mortgage.

What is the purpose of a second mortgage?

A second mortgage is a way to acquire funds to increase the value of your property. You can maintain the equity you have in your property by using the funds from your second mortgage to increase the property’s value. Additionally, the interest on a second mortgage could be tax deductible if you use the second mortgage to purchase, build, or significantly improve the home you used to get the loan for in the first place.

Be cautious when deciding whether to take out a second mortgage to pay for something that does not generate or hold value. Taking a second mortgage in Canada to go on a holiday, purchase a vehicle, or other similar expenditures is not advisable. Also, be sure to take the time to shop for lenders that offer the best interest rates – don't settle on the first mortgage lender you come across.

How does a second mortgage work in Canada?

A second mortgage works a lot like the first mortgage – at least in the initial opening stages. To secure a second mortgage in Canada, you must submit an application to a mortgage lender.

The process will include providing information and documents about your income, debts, and assets. Your home may also need a new appraisal to confirm its value. Like the first mortgage, it will also be used as collateral.

Once you qualify for a second mortgage, your approved lender deposits a lump sum payment in your bank account, which you must pay down over a predetermined period with interest. But, unlike home equity lines of credit (HELOC), you cannot reborrow the principal after you pay it off.

Most second mortgages in Canada offer short terms ranging from a few months to a few years. They typically come with fixed interest rates, although there may be some mortgage lenders that offer variable rates.

Interest rates on second mortgages tend to be higher than those on first mortgages, since there's a higher risk for lenders to lose money on your second mortgage. The main reason that second mortgages have higher interest rates is that should you default, it’s the primary mortgage lender who gets priority and takes the collateral (your home).

Is a second mortgage the same as a refinanced first mortgage? Simply put, no. A second mortgage piggybacks on your first mortgage. The first and second mortgage each have lenders the borrower pays separately.

This video discusses the features of second mortgages, HELOCs, and why you may want to take a second mortgage or refinance your first one.

How do I qualify for a second mortgage?

To qualify for a second mortgage, there are four different areas that lenders will look at:

1. Equity. For a better chance to qualify for a second mortgage, you must have more available equity. If you buy a property, you decrease the risk that a lender will be forced to take on if you make a bigger down payment. You will also be required to make consistent payments toward insurance, utilities, and telecommunications, among others, or get a confirmation letter from your service provider.
2. Income. To make sure that you can afford to make payments consistently, lenders will need reassurance. That's why you need to have a dependable source of income.
3. Credit score. Your interest rates will be less costly if you have a high credit score.
4. Property. Potential mortgage lenders will typically need to secure their investment if you cannot make your monthly mortgage payments. They will often ask for the property as collateral, because they may see other factors (like your credit score, for example) as a risk for them.

Reasons why you may need a second mortgage

There are several reasons why you would need a second mortgage, but one key reason for most homeowners is to consolidate debt. Second mortgage rates are usually lower than:

• high interest credit cards
• unsecured lines of credit
• car lease payments

Second mortgage interest rates are still typically higher than first mortgages. Using a second mortgage to consolidate debt can also help you meet these and other financial commitments on time. By taking on a second mortgage to pay for all your debt, you can improve your credit score.

Apart from consolidating debt and improving your credit score, here are other reasons why getting a second mortgage is a good idea:

Pay for a large purchase

You can use a second mortgage to modernize your home kitchen, add more square footage, add outdoor living spaces, and other major renovations. While these may sound frivolous, such renovations can add more value, and, in some cases, add more curb appeal to your home.  

A second mortgage can be used to pay for your higher education. You can also use a second mortgage to help pay for other large purchases that you typically cannot afford or want to avoid paying for with double-digit loans, such as credit cards.

Finance a second property

Assuming you plan to acquire a rental property, like a vacation home or a condo to lease out, a second mortgage can be very useful. This can provide you with enough cash for a down payment.

Use it to pay for everyday expenses

If you are overwhelmed with bills or if you’re facing a hefty emergency expense, a second mortgage can give you a cash infusion at reasonable rates. Doing this can help you push through a financially difficult time. It's also not unusual for some people to get a second mortgage from another lender to catch up with past-due payments on their first mortgage.

How much downpayment do I need for a second home in Canada?

If you’re thinking of buying another home and using it as an investment or rental property, a second mortgage with your home as collateral can help you with that purchase. In most situations, the downpayment for a second mortgage is similar if not the same as, a first mortgage.

When it comes to downpayments for second mortgages, here are some important things to keep in mind:

• For buying a second property, you’ll be required to make a downpayment of at least 20% of the purchase price.
• If you or your family members will live in the second home without paying rent, your downpayment can be less than 20%.
• The Canadian Home Buyers Plan, a feature of your RRSPs, doesn't apply on a second property – this only applies to first home purchases.
• The costs involved in buying a second property are the same as the costs for your first home. This includes valuation fees, legal fees, and registration fees.

If you’re not sure about how much you can afford for a second mortgage, you can use this calculator to determine how much you can manage to pay.

How does a second mortgage affect credit score?

This may come as a surprise, but taking on a second mortgage in Canada does not harm your credit score. Additionally, if you take a second mortgage and make the payments and adhere to the terms, it can even be beneficial for your credit score.

These could hurt your credit score, so be sure to avoid:

• making late payments on your mortgages
• making late payments on your credit cards
• canceling an old credit card
• applying for more credit or multiple lines of credit
• having a high debt-to-credit use ratio
• having legal troubles (this won't show up on your credit report, but some lenders can find out via public records)
• failing to correct any factual errors in your credit report

What is the typical rate for a second mortgage in Canada?

Depending on the lender and the borrower’s income, credit score, equity and property, their interest rates for a second mortgage can vary.

In most instances, anyone who applies for a second mortgage will see higher interest rates than their first mortgage. This is so because the lenders of the first mortgage have priority on the collateral should the borrower default and fail to make payments on the loan.

Interest rates on a second mortgage in Canada can be fixed or variable. While the interest rate on a second mortgage will surely be higher than the first mortgage, the interest rate can still be lower compared to those of credit cards and unsecured lines of credit.

Keep in mind that the fees for a second mortgage can be rather hefty. Aside from the interest, applicants may have appraisal fees, title search fees, title insurance fees and legal fees to pay.

Here are the interest rates you can expect from two common mortgage lenders, a bank or credit union and a private lender:

Getting a second mortgage: is it a good idea?

When deciding whether to take out a second mortgage, it is best to speak with a mortgage broker to help you. Looking for the best? Reach out to one of the top 75 mortgage brokers in Canada for expert advice. They’ll tell you if getting a second mortgage is a good idea based on your situation.

Remember to consider the current state of the housing market and economic conditions before deciding on a second mortgage.

A good strategy for taking on a second mortgage is to use the money to make improvements on your home to increase its value, or to buy a second property to flip into an investment or rental property.

Although a second mortgage can benefit you, it’s best to take this on only if you have sufficient income, available equity, or sufficient collateral to pay for it.

Is a second mortgage a good idea for you at this point? Let us know in the comments below