A second mortgage can help you access equity in your home, but there are several traps to avoid with this loan option.
It’s possible to take out two mortgages on a residential or commercial property. A second mortgage is a loan taken out on a property on which you already have a mortgage. While this allows you to access additional funds, it's not a suitable financial solution for all borrowers.Did you know that you aren’t limited to only taking out one mortgage on a property?
Before you decide to take out a second mortgage, make sure you understand how they work and the process involved.
How does a second mortgage work?
A second mortgage will work differently to the first mortgage you took out. A second mortgage works more like a line of credit as the money in your loan is drawn from the equity in your property.
If you're already paying off a mortgage on a property, taking out a second mortgage involves applying for another loan with the same property as security.
The second mortgage is ‘ranked’ behind your first mortgage, which means that if you don’t repay your debt and your property is sold, your first mortgage will be repaid before your second. This is one of the reasons why second mortgages are harder to find than traditional mortgages.
For example, let's assume you have a mortgage for $200,000 secured on your home with Lender A and you apply for a second mortgage of $200,000 on the same home with Lender B. If you couldn’t pay back the loans and the property was then sold for $380,000, Lender A would be repaid in full and Lender B would only receive any amount that was left over.
Keep in mind that in order to qualify for a second mortgage, you must seek permission from your existing lender.
Why should I take out a second mortgage?
For the majority of borrowers, refinancing their existing loan with another lender offers a less risky option as it allows them to access a higher amount. However, in certain cases taking out a second mortgage can be beneficial.
For example, if you want to access some of the equity in your home but your existing lender has refused your request for a larger loan amount, a second mortgage could be a viable option. This could also be the case if your first mortgage is a fixed rate home loan — not only will you need to worry about expensive exit fees if you refinance, but the fixed rate you have locked in may be substantially better than the current variable rate available.
Another common situation where a second mortgage can be helpful is where you are guaranteeing a loan for someone else, such as if you're using your home as security for your child's home loan. In this case, the second mortgage provides added security for the bank, allowing them to recoup their losses in the event that your child defaults on the loan.
Is it difficult to qualify for a second mortgage?
Most Australian lenders are reluctant to approve an application for a second mortgage. This is mainly because second mortgages are seen as a high-risk borrowing option and due to the lower priority placed on the second mortgage. If you default on your loans, only when the first mortgage has been repaid will the debt on the second mortgage be attended to — so lenders face a much higher level of risk when approving a second mortgage.
With this in mind, the majority of lenders will either place tight limits on the amount you can borrow or simply refuse to offer you a second mortgage altogether. But there are lenders who can help you if you need a second mortgage, so contact a trusted mortgage broker for assistance.
If you want to take out a second mortgage, you'll need to get approval from the lender which financed your first mortgage. You'll typically need to pay a fee of a few hundred dollars to get the first lender to assess your request.
If you’re taking out a second mortgage with the same lender that offered your first mortgage, you may be able to borrow up to 95% LVR (loan to valuation ratio). Meanwhile, borrowers taking out a second mortgage with a different lender may be able to access a loan with up to 85% LVR allowed.
If you’re self-employed and looking for a low doc loan, you won’t be able to get approval for a second mortgage unless you go through a private lender, which is not recommended.
Benefits of a second mortgage
People choose to take out a second mortgage for a wide range of reasons. Here are a few of the benefits that people look at getting from a second mortgage:
- Access equity. A second mortgage allows you to access the equity in your home which can help free up your cash flow.
- Debt consolidation. Accessing the equity in your home means you can work towards paying down and consolidating your debts.
- Alternative to refinancing. A second mortgage also provides an alternative to refinancing, which may involve break costs, exit fees and other legal fees.
- Home renovations or repairs. Accessing home equity can also allow you to make much-needed home renovations or repairs, which can also increase the value of your property.
- Going guarantor. If you are going guarantor on a loan for a family member or friend, then you can use a second mortgage over your property as additional security for the bank or lender.
Things to consider about second mortgages
Taking out a second mortgage isn’t a decision that should be taken lightly. You should go through all the same considerations you did with your first mortgage, as this is just as serious of an undertaking. Second mortgages come with higher interest rates, so you’ll need to make sure you’ll be able to afford the additional repayments.
To get an idea of the added expense, it might be a good idea to use a mortgage calculator to work out what your repayments are likely to be, and then see if they will be manageable on your current budget. As with any other mortgage, you should also consider the rates and fees that are associated with the loan, as well as the terms that are being offered by the lender.
Risks of a second mortgage
Before you even consider taking out a second mortgage, make sure you’re fully aware of all the risks and drawbacks of this approach:
- Taking on more debt. Whichever way you look at it, borrowing more money on top of the amount you already owe is risky. Make sure you can afford to make repayments on two mortgages before you adopt this approach.
- Cautious lenders. Most Australian lenders take a conservative approach to lending money, so the increased risk of financial loss they face with second mortgages makes them hesitant to grant loan approval.
- High fees. As a general rule, second mortgages attract higher fees across the board than first mortgages. You’ll also have to budget for a fee your first lender will charge before providing their consent for you to take out a second mortgage.
- Lower LVRs. Second mortgages usually attract lower maximum loan-to-value (LVR) ratio than first mortgages, which means you won’t be able to borrow as much money as you would on a normal home loan. On average, lenders will generally agree to let you borrow between 60% and 80% of the property’s value, although this may be slightly higher if your first and second mortgage are with the same lender.
- Managing two loans. Managing one home loan and staying up to date with repayments can be tricky enough in itself, so servicing two separate mortgages can be even more complicated and confusing — especially if the loans are with two different lenders.
- Limited choice. You will most likely find that only the bigger banks and lending institutions will be able to offer you a second mortgage, so you will need to accept the fact that there is limited choice available.
Where can you get a second mortgage from?
A second mortgage isn’t regularly available through mainstream lenders. Rather, they’re usually available through mortgage brokers, solicitors arranging funds through private investors, or through vendor finance.
How to apply for a second mortgage
The application process for a second mortgage is similar to that of your first mortgage, with a few key differences. For instance, you’ll have to provide details of your existing loan in addition to your personal and financial details. If you’re taking out a second mortgage on a commercial property, you may also have to provide some business details as well. Specific eligibility requirements will differ between lenders, so be sure to compare your options and find a loan that you’ll be eligible for.
While second mortgages can be beneficial in some circumstances, they do come with some inherent risks. Make sure you’re aware of all the traps and pitfalls before you decide whether a second home loan is right for you.
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