Mortgage Rate Forecast in Canada: Where Will Rates Go?
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mbrowne
12 January 2025
Should you Get a HELOC, 2nd Mortgage, or Replace your Mortgage
- mbrowne
What's the difference between a HELOC, 2nd Mortgage, and an Equity Take Out Refinance?
What is an Equity Take Out Refinance?
An Equity Take Out Refinance (ETO) is when you restructure your current mortgage to pull out the equity remaining in the property. When doing an ETO, it is always with the same lender.
This can typically be done one of 3 ways:
- Your existing lender can replace the current mortgage with a larger mortgage. By doing this, they will effectively give you a bank draft for the difference. The mortgage will show up as one whole new mortgage.
- Your existing lender can add on a 2nd portion or 2nd mortgage account. By doing this, they bank will leave the existing 1st portion the way it is and give you a 2nd portion on top. They will give you a bank draft for the balance of the new mortgage portion and it will show up as 2 mortgages.
- Replace the existing mortgage with a mortgage from a new lender while simultaneously taking the equity out. You can either do this as one whole mortgage or you can replace the 1st portion with a new 1st portion and then add a 2nd portion behind. All of this would be with a new lender.
What is a 2nd Mortgage?
A 2nd mortgage is another debt product that’s placed “behind” a 1st mortgage on the real estate title.
What this means is that they are taking 2nd position so if you foreclose, the 1st lender get’s priority to the payout, then the 2nd lender get’s second priority. This is important because it will affect the risk to the lender and therefore the rate and fees involved.
Other than the priority and costs, a 2nd mortgage is loosely no different than a 1st mortgage. 2nd mortgages typically happen when you need to use a different lender from the lender in 1st position.
What is a HELOC (Home Equity Line of Credit)
A HELOC is technically a mortgage, but it’s what is called an “open mortgage”. This means you can use the funds anytime and pay them back anytime without penalty. It acts exactly like any Line of Credit.
In most cases you would get a HELOC with your existing lender, so it would really be classified as an Equity Take Out Refinance as above.
Sometimes it doesn’t make sense to go this route and you need to use a different lender. In that case, it is technically classified as a 2nd mortgage. The difference being the revolving nature of a line of credit.
What are the Benefits of each Method to Access Equity in your property?
What are the advantages of doing a full Equity Take Out Refinance?
By doing an equity take out refinance, you would likely be getting the best rate options available. This is because all of the debt is with the same lender, there would not be a 2nd position with higher rates.
Also, since the debt is all with the same lender you have a few admin benefits:
- Your book keeping will be more streamlined
- You won’t have to go to several lenders or institutions to access the accounts
- You won’t have to worry about multiple maturity dates
What are the advantages of a 2nd mortgage?
The biggest benefit of getting a 2nd mortgage behind another lender is that you don’t need to “break” the 1st mortgage contract.
If the penalty and costs on breaking the 1st mortgage are very high, it can make sense to pay the higher costs of a 2nd.
Ideally, your mortgage agent or broker should be going over an “exit” plan with you. This exit plan would likely be to refinance the entire mortgage structure at the renewal date of the 1st mortgage.
What are the advantages of getting a HELOC?
The biggest benefit to getting a HELOC as opposed to a standard mortgage is that you don’t make any payments until you use the funds.
This can be most beneficial if you have an undetermined timeframe to use the funds, or if you know you won’t need the funds for quite a while but you want it in place just in case.
With almost every lender, you can lock in a HELOC balance into a mortgage term at the rates at time of locking. This can reduce the interest cost and is very commonly done for real estate investors.
What are the Disadvantages of each Method?
what are the disadvantages of doing a full equity take out refinance?
This option can be quite expensive IF you are in a fixed rate mortgage with a lot of time remaining.
The reason that it can get expensive is fixed rate mortgage typically use an Interest Rate Differential (IRD) penalty. This penalty can be quite hefty so it’s important to run the cost and benefit compared to a 2nd mortgage.
If you do an ETO as a mortgage only product, the payments on the new funds happen right away. This means, if you don’t need the funds for a while, you will be paying interest even before you use the funds.
What are the Disadvantages of getting a 2nd mortgage?
2nd mortgages have higher costs than a simple ETO.
Because the lender is going “behind” the 1st institutions mortgage, they are at a higher risk and so will charge additional rates (and in some cases fees).
Similar to the ETO, you would be paying interest right away if you get a 2nd mortgage instead of a 2nd HELOC.
What are the disadvantages of a HELOC?
HELOC’s are almost always variable, interest only payments. This can increase your interest rate risk. The rates are also typically higher than mortgage rates – this is due to the inherently higher risk to the lender.
HELOC’s can only go up to 65% loan to value of the property if stand alone. The global debt limit (mortgage balance + HELOC limit) can only go up to 80% loan to value of the property.
Summary and how to pick the right product for you
If you’re planning on taking equity out of one of your properties, you’ll need to consider a few things to determine the best course of action.
The main questions I ask my clients when selecting the product choice are:
- What do the penalties and costs look like for each option?
- What time frames do you anticipate needing the funds?
- Where are rates currently and does it even make sense to be accessing this equity?
- Have you added the cost of accessing these funds into your pro forma for your next investment?
Here’s a summary of the pros and cons of each Method of accessing equity
P.S. I offer 30 minute, free and no obligation consultations to review mortgages and scenarios. I have an internal calculator to give you real world numbers for your situation.
schedule a review here
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mbrowne
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