In the last 15 year years, property values across Canada have gone up quite a bit (in case you've been living under a rock). Depending on when you purchased in major markets, like Toronto and Vancouver, it could feel like you won the lottery. Fifteen years ago a nice home (not a mansion, not an architectural masterpiece: a nice home) cost about $350,000. Now that same house sells for well over $1 million in these red-hot markets. Or in some cases, tear-downs sell for more than $2 million.
Now that you have a substantial amount of equity in your property from which you may want to borrow some additional funds, maybe you want to (finally) tackle that renovation. Or you have a child headed off to college or university. You may have heard about second mortgages but aren't sure how they work.
Your first question should be, "do I really need a second mortgage?" Have you considered other options for financing your requirements? Can you borrow from the banks at a lower rate? Will a family member lend you the money?
Once you have determined that a second mortgage is your best solution, you need to understand the terms and conditions of a second mortgage and what to look for in a second mortgage. Second mortgages will have a higher interest rate since they are riskier than a first mortgage. The lowest rate I have ever seen on a second mortgage is six per cent and the highest is 29.9 per cent (which is the highest legal rate a lender can charge in Canada). To get the lowest rate, you need to have a good credit score, verifiable income and a large amount of equity in your home. The average interest rate for a second mortgage is about 10 per cent right now. If you can only get a second mortgage with an interest rate that is above 15 per cent, maybe you should really consider not getting a second mortgage. If you need to borrow an amount less than $15,000.00, a second mortgage will be very expensive due to the legal and broker fees.
Second mortgages are usually provided by small financial institutions or private lenders. Most people that need a second mortgage will need a mortgage broker to arrange the loan for them. Since not all mortgage brokers specialize in second mortgages, you will need to find a mortgage broker that does. Before you sign anything, here are some questions to ask:
What are the broker fees for arranging the mortgage?
This is a question that some brokers hate when potential clients ask, because if they answer it honestly, they might scare a client away. Many will try to evade this questions until the very last minute to tell you their fees and by this time, you feel pressured into just accepting the mortgage and the fees. The actual amount of broker fees depends on a few factors, amount of money borrowed and how much time a broker spends arranging the mortgage. For example, a small second mortgage of $20,000 could have a broker fee from $2,000 to $3,000. A second mortgage of $80,000.00 could have a broker fee of $4,000 to $6,000. The more you borrow, the lower the broker fee will be as a percentage of the mortgage. However, if there are legal issues such as a marriage separation, foreclosure or eviction, you can expect a higher broker fee.
Is an appraisal required and how much will it cost?
In most cases an appraisal is required by the lender, but some prefer a personal inspection of the property. The appraisal or inspection is for the benefit of the lender so if the lender does not require an appraisal that will save you some money. If you need your own appraisal a
Certified Registered Appraiser can be found at www.aicanada.ca.
Do I need a lawyer, will this cost more?
For a second mortgage, you should have a lawyer that acts in your best interest. Your lawyer will review the mortgage documents and ensure that you understand exactly what the terms of the mortgage are. Most lenders insist that all mortgage clients have their own legal representative. If a broker tells you do not need a lawyer maybe you should consider a different a mortgage broker. The average legal cost to set up a second mortgage is about $1,500 to $2,000. Each provincial law society has a listing of its lawyers so that you can make an informed decision. In Ontario, the Law
Society of Upper Canada has its listings at www.lsuc.on.ca.
Can you pay off this mortgage without any penalties?
Most brokers charge at least a three-month interest penalty for early or late mortgage repayment. The best date to repay with most lenders is on the renewal date.
Many people that decide not to get a second mortgage after they fully understand the cost of getting the mortgage. If you need an amount less than $15,000, consider your other options before you go with the second mortgage. Remember the cost of a second mortgage are somewhat fixed. You need a lawyer, broker, lender and an appraisal. The minimum cost of these combined services is, at least, $4,000 and they go up from there. Be really specific in asking about penalties if you default. What are the charges per default? For instance, one large second mortgage lender will charge $250 for each late or NSF cheque, whereas another lender only charges $20 per NSF cheque. It is important to do your homework.
Ask the broker questions about how strict the lender is in enforcing its rules. Some lenders are very aggressive and start the power of sale or foreclosure process on you right away. Others will wait many months before they start any legal proceedings.
As the borrower, you should always consider how you are going to pay off the second mortgage before you get it. Is your goal to pay it off when you sell the house or roll it into your lower interest rate first mortgage when it renews. If the mortgage broker cannot give you an estimate of what their fees are, then you should consider getting a new broker!
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Before any fun can be had, it's best to use that remaining money to pay off any and all remaining debts that may be outstanding, starting with the debt with the highest interest. At the end of 2012, the average consumer debt load in Canada was $27,485 — a six per cent increase over the previous year and the fastest increase since 2009. Sure, such financial housekeeping seems boring and monotonous, but you'll thank yourself later. After all, financial freedom when other debt still hangs over you is nothing but a facade and the longer such debt is avoided and ignored while you live the high life, the sooner you'll be in an even deeper financial hole.
A number of financial experts and personal finance articles recommend paying off your mortgage before investing in your retirement, but once your mortgage is paid off, why not allow the money you are now saving to grow even further in an investment to put towards retirement? There are always a number of investment options to choose from, whether it be high risk high reward stocks, GICs, savings accounts, or mutual funds. What you choose is dependent on your risk tolerance and investment knowledge and your risk tolerance depends on how long the money will stay invested. More time means you can afford to take higher losses, but if you plan to cash out, you'll want to keep your losses to a minimum.
Once all outstanding debt is paid off, it's time to have some fun and live your dreams. An around the world ticket can be purchased through travel websites for less than you may think. The cost is determined by the number of countries you plan to visit, the class of your cabin and the total mileage the plane will be traveling. You'll also want to consider the flexibility that your trip allows and possibly using discount airlines, buses, or trains for shorter distances on your trip if money is still a main concern. An around the world cruise is also an option if money is no object and you want to live it up, with costs dependent mainly on your steerage class with trips ranging from $20,000 to over $100,000 depending on the cruise line and the type of room chosen.
Maybe you hate your job or maybe you just want to spend more time with the family; either way, no longer having the financial burden of a mortgage means you can start working the way you want. You can plan to retire sooner, thanks to all that extra money, maybe consider working part-time or even reinvest in yourself by changing jobs and doing what you always wanted to do or starting your own business and becoming a true entrepreneur.
Depending on how early you get your ducks in a row, paying off your mortgage may line right up with your kids, or possibly your grandchildren, going off to university. With the cost of tuition and living on your own being around $80,000, the kids will need as much help as they can get. If your kids have yet to reach university age, you can use your extra funds to make the maximum RESP contributions, as often paying a mortgage is a major barrier to parents making the real impactful contributions they want to their kids' education.
You may want to take that extra money and reinvest in your home. Those long planned renovations you always wanted to do can finally be moved to the forefront now. It's a great way to increase the value of your home if you sell it down the road. You could even put the renovation expenses on a line of credit and pay them off like you did your mortgage for a time.
Speaking of selling your home, many retirees realize that their home is actually more spacious than they need it to be, so it's common for many of them to downsize. The money you save from the sale and subsequent downsizing will only add to your financial options. The world is your oyster; now go out and claim it!
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