In my opinion, there are very few instances when a second mortgage makes sense. The problem with a second mortgage is the interest. As I write this article, first mortgages rates are between 2 ½ to 4%, while second mortgages usually run from 12 to 18%. By comparison, a secured line of credit costs 4 to 7%, while an unsecured line of credit might run between 7 to 10%. Given the choice, why would someone agree to 12 to 18% if these other options are available?
“But these other options aren’t always available”, you say. True, but if they are not perhaps the bank is telling you something. Perhaps the bank thinks you are asking for more credit than you can afford. Perhaps, it’s a warning that it is time to get your finances in order…
Clear Up Your Debts, Don’t Take On New Ones
Now consider a consumer proposal. In case you’ve never heard of a consumer proposal, or you aren’t sure what they are, here’s a quick description: a consumer proposal is an arrangement you make with your creditors to repay a portion of what you owe. There are no new interest charges once you file a consumer proposal – your payments go directly to paying down the total your creditors have agreed to accept to eliminate your debts.
Let’s be perfectly clear – consumer proposals are designed to help people reduce their debts to more manageable levels. They aren’t a form of new borrowing – consumer proposals allow you to clean up old borrowing.
As to which is better, a consumer proposal or a second mortgage, I’d pick a consumer proposal. At the very least, the fact that the consumer proposal carries no new interest charges means you will save thousands of dollars in interest over the term of the proposal, not to mention the amount you may save by negotiating a reduced total payment.
Let’s try an example. Bob and Mary owe $60,000 in credit cards, lines of credit and unpaid income taxes (this is the amount our average client owes when they come to see us). To keep things simple, let’s assume Bob and Mary have $60,000 equity in their home and have been approved for a second mortgage that will give them access to the full $60,000. At 12% interest, amortized over 7 years, the payment will be $1,050 per month for a total repayment of $88,200. A consumer proposal would be $1,000 per month for 60 months (5 years) for a total repayment of $60,000. A savings of $28,200.
I have tried to think of an example where the second mortgage would produce a net savings over the consumer proposal and I couldn’t. Even if you were able to borrow the second mortgage money from a family member at 0% interest, the mortgage only matches the consumer proposal, it doesn’t beat it.
There are other factors that may come into play when making this kind of decision, like whether you owe more than the equity value in your home, but just based on the cost of borrowing (the interest you will pay) a consumer proposal is better than a second mortgage.