We are often asked if a client should break a mortgage or take a second mortgage.
In a picture perfect scenario we’d have buckets of cash laying around at our disposal. Perhaps available credit on a line of credit with a very low interest rate. Unfortunately, this is not usually the case.
There isn’t a one size fits all answer, and like everything mortgage-related, it comes down to cost and strategy.
Bill is wishing to borrow $30K to address income tax arrears and only requires the funds for 1 year. He is only only 2 years into your 5 year fixed first mortgage with a current balance of $500K at 2.69%.
His existing lender isn’t prepared to advance him additional funds due to the tax arrears, and he was advised that the prepayment penalty to break his existing first mortgage is $10,000.
In other words, it will cost Bill $10,000 to borrow $30,000 and this is assuming Bill qualifies for the exact same interest rate and the bank doesn’t have an issue with the outstanding tax arrears which usually is an issue.
Bill has excellent equity in his primary residence and would therefore qualify for a second mortgage at a low rate of only 8.99%. Let’s just assume that transaction and lawyer costs will equate to roughly $4K . When we include the annual interest of $2,697 to the $4,000 transaction cost, we reach a total of $6,697. Therefore, a second mortgage is roughly $3303 or 33% cost friendlier to achieve borrowing $30K.
We must keep in mind that second mortgages are short-term solutions.
Interestingly enough, we have clients that maintain second mortgages for years as it is still the ‘best’ option for them.
From a strategy standpoint there are a few things to consider.
-The existing first mortgage still has a few years to maturity.
-The second mortgage lender may grant additional extensions or renewals, at a cost.
-The second mortgage lender may not offer a renewal, therefore Bill would need to source a new second mortgage.
-Bill has addressed his outstanding income tax arrears and his taxes are filed and up to date which is required for institutional mortgages.
In an ideal world, Bill would analyze the:
- cost of renewing/replacing the second mortgage up until maturity of the existing first mortgage, at which point he would consolidate both mortgage into one traditional mortgage.
- cost of breaking the existing first mortgage prior to maturity to consolidate both mortgages versus maintaining a second mortgage until first mortgage maturity.
Bill would chose the option that makes most sense for him.
Assuming market rates are no higher than his existing first mortgage rate, income and employment are sufficient to qualify, and credit is acceptable, Bill should have an easy strategy back to a traditional first mortgage.
Should Bill’s circumstances, interest rates, or qualifying power change, Bill would follow the same approach. Which is to find the cost-friendliest, and most suitable mortgage game-plan.
While this is only an example, it touches base on what is most important to consider: cost and strategy.
If you have any questions or would like a quick mortgage game-plan discussion, contact us at anytime.
-DV Capital Corporation 13186