Second Mortgages; that word is usually followed by a shiver down the spines of Home Owners across Canada. But have you ever actually done any research on the topic to know why you’re scared of them? Albeit in most cases they are obtained by those with credit issues, however there are several instances where a second mortgage can be a very useful financial tool. In this article, we are going to focus in on one of those scenarios, likely to most common; how to consolidate debt using a second mortgage and rebuilding credit with a second mortgage.
Life happens. That is the reality. Some things are planned, some not. Sometimes mistakes are made from lack of knowledge and some from lack of experience. Sometimes unexpected events come up leaving us in a vulnerable position and these events can sometimes leave an unpleasant mess to clean up. A common one is unwanted debt and seemingly unmanageable payments. So what do you do when you have racked up a debt load of say, $50,000? This could have come from credit cards, Lines of credit, major damages at home, personal issues, or even those formerly attractive don’t pay for 6 months retail cards. Whatever the path was that got you here, it’s time to get out. Now with debt that high and an average income, you would likely be making the minimum payment and barely making a dent in the balance. Your credit is now too low to get a new first mortgage, what to do? Enter the second mortgage.
Let’s imagine the following scenario:
Home Value – $400,000
First Mortgage – $220,000 / $1,250/month payment
Debts (Credit card, Line of credit, etc.) – $50,000 @ 18% – $1,500/month minimum payment
You have gotten yourself into a little bit of a predicament and built up a good chunk of debt for whatever the reason may be and your credit score is now less than favourable. The amounts have grown to be not so manageable and in order to keep up with your payments, mortgage, taxes, cost of living, and whatever else, you are only able to pay the minimum payment at best. Tough situation to find yourself in.
Using the numbers above, we are going to imagine you have $50,000 in debts built up using 3% as a minimum payment of $1,500/month without even making a dent on the principal balance. Remember, your credit is beat up so a new first mortgage is out of the questions, what to do? Sell the house? Not quite. Enter the second mortgage.
Step 1 – By getting a second mortgage to pay out all these debts ($50,000), you would eliminate the $1,500 payment and incur roughly $500/month for the second mortgage. This would be set up on a 1 year term. Over the course of the year, your credit would climb back up to higher levels and you would be saving $12,000 over the course of the year. How much pressure would that alleviate for you?
Step 2 – A year has now passed and your credit is at levels required for “A” lending and there is enough equity in your home to do so (you can borrow up to 80% of the value of your home). You saved $12,000 in payments over the year which you were able to use to catch up on the rest of your life, maybe take a much needed family vacation or update the washrooms. You are now ready for phase 2 of the debt consolidation plan; refinancing your first mortgage to combine the first and second mortgage into one new first mortgage. So let’s assume your first mortgage balance dropped down to $215,000 over the past year. You add on the $50,000 second mortgage and have a new first mortgage of $265,000 an interest rate of 2.59% and a total payment of $1,057.59/month. In shock? Well believe it people. Let’s compare once more.
* Estimated numbers only. This is only an example and not an offer of any kind. Your numbers could vary from this.
Look at the difference you have made. You went from a seemingly hopeless scenario to back in the game. With the right advice and proper strategy, a second mortgage can be an invaluable asset in consolidating debt and rebuilding credit. There are also other scenarios in which a second mortgage can be useful, such as making a short term investment or renovations where you want to keep monthly costs low. Understanding something can change your opinion on it and a 2nd mortgage is a good example of this. We’re not saying to go out and slap a second mortgage on your house. Obviously if you have other means of handling the scenarios above, it would not be wise to pay high mortgage rates for no reason. However, under the right circumstances like using a second mortgage to consolidate debt, a Private loan can be a helpful tool to get you back on track!
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