The work and lifestyle changes brought on by the pandemic have many Canadian homeowners thinking about buying second properties – whether it’s a cottage, a pied-à-terre or helping adult children buy a home in a hot housing market.
Record-low interest rates are driving the search for these places, and some Canadians are using the considerable equity built up in their principal residences to seal the deal.
“The goal is to unlock the equity in your home,” says Elan Weintraub, co-founder and mortgage broker at Mortgageoutlet.ca.
There are many issues and strategies to consider with this kind of financing, Mr. Weintraub says, depending on your real estate status and objectives.
Ways to finance a second property
Often the best option is to refinance your current mortgage. This loan, called the “first-position charge on the title,” is likely to come at the lowest rate, so it’s the best way to free up funds from the equity in your current property, Mr. Weintraub says.
If that’s not possible or advantageous due to fees, rates or terms, you can use the equity in your home as security against another loan, which becomes a “second-position charge on the title.” A popular option for this is through a home equity line of credit, or HELOC, a loan offered by a bank, credit union or other lender that’s secured by the value of your home, so it comes at a relatively low rate, Mr. Weintraub says.
Depending on your credit and income, the interest on a HELOC may be just half a per cent above prime. This rate is typically slightly higher than a first mortgage, reflecting the added risk to the lender of being paid second if you default.
There are also “second mortgages” offered by private lenders, he notes, which are typically used to consolidate debt if the borrower has suffered a job loss or credit problems. These come at a higher rate, even into the double digits, given the greater risk involved.
John Webster, head of real estate and secured lending at Bank of Nova Scotia, says second-position loans have evolved a lot from the classic “vendor take-back” second mortgages that often had to be offered by the sellers of homes back in the 1960s when buyers did not have adequate down payments or couldn’t qualify for sufficient mortgages.
Today, Mr. Webster says homeowners are looking for ways to take advantage of their properties’ rapid appreciation. They are also rushing to snag vacation places as the pandemic drives up demand, he notes, with cottage prices jumping 30 per cent in some parts of the country.
Lenders are more than willing to offer solutions through home equity plans. Indeed, in many cases when borrowers get a first mortgage they are automatically eligible for a HELOC that reflects the accrued equity in the property.
“Your credit limit goes up with the value in your home,” explains Mr. Webster, noting that HELOC funds can be used to finance a secondary property for yourself or your children, to fund renovations, buy a new car or myriad other purposes. A HELOC is typically flexible, so the money can be withdrawn, repaid and even reborrowed at any time; you just pay interest on the amount you owe, he says.
Canadians can get up to 65 per cent of the value of their home through a HELOC, Mr. Webster says. However, the outstanding mortgage loan balance plus the HELOC generally can’t equal more than 80 per cent of the home’s value.
Mr. Weintraub says using funds from a HELOC makes the most sense when buying land, rustic cottages or foreign places, which can all be difficult to finance. “If you add a HELOC to your existing property, you can write a cheque for the new place,” he says.
Seek advice for a second home purchase
Taking an additional mortgage is a big decision for many Canadians. Mr. Weintraub suggests homeowners discuss their goals and options with their current lender and seek a second opinion from a mortgage broker. Also, get some financial planning, legal and accounting advice. For example, if you borrow funds for a property that generates income, you may get a tax benefit on the interest you pay.
It’s also possible to customize second mortgages, Mr. Weintraub says, such as when parents gift or loan funds to help their children buy a home when they get married. Rather than simply write a cheque, the amount can come as a second charge on the property, which he calls an interest-free “mom and dad second mortgage.” This allows the parents to protect the money if the marriage breaks down or even to recoup their funds when the home is sold.
Jonathan Hacohen, a partner at Kormans LLP practicing real estate and commercial law, says parents who give funds to their children for real estate should be aware of “extra complications.” If several family members contribute to such transactions, they might have different tax exposures or expectations about being repaid, for example.
“Get all the uncomfortableness out of the way” upfront, he says, and involve advisers to make sure things are properly structured.
Can you manage a second property?
Mr. Hacohen’s No. 1 rule for people buying secondary properties: “Do not sign a contract to buy real estate unless you are sure the money is going to be there to carry it.”
He has seen clients take what they consider to be “free money” from their principal residences and invest it in rural properties that then require massive upkeep.
“It comes at a price,” he says of purchasing a second home. “Speak to professionals, have a game plan and be sensible about it.”
People looking to buy a second property should be comfortable that their income level will be there to support it, Mr. Webster adds, based on factors such as their age and stage of life.
He suggests looking at the breakdown of borrowing options given related fees, rates and rules.
“Typically, you’re going to take the path that’s simplest, cleanest and cheapest,” he says.