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Second Mortgage

April 23, 2019

Second mortgages used to be viewed as something that ought to be avoided at almost any cost, these days not only are second mortgages common, but many people have third and forth mortgages.  But why the bum rush on mortgaging property?  Its all about the illusion of managing debt.

After running up $30,000 on credit card debt and paying $600 per month towards minimum payments and watching the debt increase year over year many people resort to consolidation through mortgages.  They figure that since the $600 is doing nothing to reduce the debt they may as well put it into a mortgage that will help pay down the principal.

How logical is that solution?  On the face of it there is the perception of relief until one does the math.  Mortgages are certainly easier to sell than more viable solutions such as bankruptcies or proposals.  So, let’s weigh in on the math as well as some of the other consequences:

Your mortgage broker can only find you a high-risk lender, who is willing to lend you $30,000 to pay off your 24.99% interest credit cards.  The mortgage will bear interest at 12%, higher than you wanted but certainly less than the 24.99% you have been paying.

Cashflow is one of biggest concerns and putting out $600 a month on a debt that is going nowhere feels like a jail sentence.  After talking it over with your spouse, you agree to the mortgage.  But you also must pay the mortgage broker a finder’s fee and then there are legal costs to register the mortgage.  Of course, you don’t have the money to pay those costs, so you borrow $35,000 to cover everything.

To keep your cashflow under control and give you breathing space, you sign on for interest only payments, under the understanding that you can increase payments at any time to pay down the principal.  What a relief to only have payments of $350 per month.  Now you can afford to take your spouse out for dinner.

Life seems to be a little better and you plan to get around to paying a little extra on the mortgage but when your daughter heads off to university and needs a new laptop and printer all bets are off.  In fact, you put the computer, printer and notepad on your Best Buy credit card, after all the payments are only $35 per month and you can afford to cash flow that.

Before the year is out you have bought new clothes, some furniture, car repairs and even gasoline and groceries on your credit cards.  In your mind you keep thinking “$5,000 on credit cards is only $100 per month, so I am still further ahead than I was”.  Don’t feel bad if this scenario applies to you, tens of thousands of Canadians are doing the same thing.

By this point, you are hoping the real estate boom keeps going so that your house increases in value and you can refinance the second mortgage into the first at a lower rate.  The story continues to unfold until the credit cards have been consolidated into lines of credit and run up again.  A friend reminds you that there are debt relief options under the Bankruptcy and Insolvency Act.

As you enter the Licensed Insolvency Trustee’s office you feel a jolt of fear and trepidation surging through your mind and body.  The trustee offers you options to deal with the whole debt situation or just the unsecured debt.  You ask about the second mortgage, including it but keeping the first, the trustee points out that can only happen if you are prepared to walk away from the house.

That was not something you anticipated, and you are not willing to entertain selling the family home.  But since your credit card and line of credit debt is back up to $30,000 you decide to make a proposal to your creditors, paying $150 per month for sixty (60) months.  Your creditors accept and start making your monthly payments knowing that the end is truly in sight.

Your second mortgage comes up for renegotiation on the third anniversary and the lender advises they aren’t interested in renewing.  Now you need to scramble to find another lender who is, luckily your mortgage broker finds someone else who will offer you the $35,000 to pay out the existing second, but at a higher rate of interest, 14%.  Once again you need to add $5,000 in costs to the financing arrangement bringing the total amount borrowed up to $40,000.

You monthly payments for the new second mortgage increase to $470 per month, adding that to the $150 for the proposal you are now putting out $620 on what was originally $30,000 of credit card debt but is now $49,000 and you have already paid over $13,000 in interest without reducing anything.

If you default on the second mortgage, at some point, the lender will move for a power of sale, which will usually erode any notion of equity you might have in the property.   Typical powers of sale cost anywhere between $10,000 to $20,000 and often include a lot of unforeseeable costs.  The moral of the story – mortgages are no panacea and often end up costing far more than anticipated.