The balance that grew while nothing was paid

The borrower had been tracking the private second in their head as a $65,000 debt. It was not a wrong number when the loan was advanced — it became wrong over the 24 months that followed, one unpaid interest instalment at a time.

Nothing here was hidden or unusual for a private second mortgage — the loan agreement said interest not paid currently would be added to the balance, and it was. The problem was entirely one of expectation: the borrower had never actually done the arithmetic on what 24 months of that would add up to, and the payout statement did the arithmetic for them, all at once, at the worst possible moment to be surprised. Every private deal needs its own exit strategy planned in advance, and a capitalizing-interest term is exactly the kind of clause that exit plan has to account for from day one, not discover at payout.

Every dollar the second's balance grew came directly out of the cash-out the exit refinance could deliver — a mechanism worth understanding on any file where arrears risk pushes a borrower toward letting private interest accumulate rather than default outright.

Qualifying at 7.45% (5.45% new-lender contract rate + 2%): the trimmed scenario's payment comes to $2,085/mo, for TDS of 36.1% — almost identical to the 36.0% the borrower had originally budgeted for, achieved by giving up $15,000 of the hoped-for cash-out rather than by carrying a materially larger mortgage.

A mortgage broker arranging financing in Prince Edward Island, where no dedicated mortgage-broker licensing regime exists, treated the payout statement as the starting point for a real conversation, not a number to work around quietly.

First, ordered the private lender's formal payout statement before structuring anything. A borrower's own running estimate of a private balance is not reliable once any interest has gone unpaid; only the lender's own statement, calculated to a specific payout date, is.

Second, showed the client both scenarios side by side. Funding the full $25,000 cash-out at the true $81,248 second balance was not impossible — TDS would still have cleared this lender's comfort ceiling at 37.5% — but it left less room than the client had been expecting on every other part of the budget. That is the whole point of an exit strategy conversation happening before the payout statement lands, not after.

Third, let the client choose the trade-off rather than making it for them. Trimming the cash-out ask to $10,000 kept the file at essentially the same comfort level as originally budgeted, at the cost of less cash in hand — a deliberate choice, not a shortfall the file forced on anyone.

The private second was paid out in full at its true, capitalized balance of $81,248. The new institutional mortgage funded at $286,248 with the cash-out trimmed to $10,000, and TDS settled at 36.1% — a file that qualified comfortably rather than at its limit, with the borrower fully informed of the trade-off before signing.

Because this is an uninsured refinance, there is no CMHC ratio ceiling; the 36.1% figure reflects this particular lender's own comfort range, not a regulatory maximum.

• 01Unpaid private interest doesn't disappear — it compounds onto the balance. A private second that looks unchanged month to month can be growing the entire time.
• 02Never structure an exit refinance off a borrower's own running estimate of a private balance. Only a formal, dated payout statement from the private lender is reliable.
• 03Capitalized interest reduces cash-out dollar for dollar. Every dollar added to the second's balance is a dollar the exit refinance can no longer deliver to the borrower.
• 04Show the client the full-cash-out and trimmed-cash-out numbers side by side. The trade-off between cash today and ratio comfort belongs to the client, not the broker.
• 05Ask up front whether a private agreement's unpaid interest compounds or simply adds on. The two produce different growth over time, and the agreement itself should say which applies.