What is a second mortgage?
A second mortgage is an additional mortgage you can take out on a property that already has one, borrowing against the equity you’ve built up in the home.
If you want access to additional funds to purchase an investment property, help a family member out with a house deposit, or even consolidate other debts, you could leverage the equity you’ve built up over the years by taking out a loan as a second mortgage.
How is a second mortgage different from a primary home loan?
A second mortgage is subordinate to a primary one, meaning it’s lower in terms of priority if you default, but needs to be repaid just like the primary mortgage.
A second mortgage doesn't have to be with the same lender as your primary one, and doesn’t replace it. That said, if you do decide to take out a second mortgage with a different lender, your main one will need to give their permission to register a different lender as an interested party on your property title. Additionally, the second mortgage lender gets second priority on any proceeds of sale if you default and your lenders sell your property to recoup their funds.
There are some key differences between a second mortgage and a primary one, namely:
- They tend to come with higher interest rates, as banks view them as riskier.
- They also have shorter terms than primary ones, often 10 to 20 years, rather than 30.
- Their eligibility requirements are often stricter than those for primary mortgages, making them more difficult to get.
How does a second mortgage work?
A second mortgage works by tapping into your equity, essentially borrowing against the portion of your property you already own.
Equity is the difference between the value of the property and what you owe on your mortgage. Homes tend to appreciate in value over time, so if you’ve owned yours for a while and have been diligently paying off the mortgage, chances are you’ve built up a chunk of equity.
Taking out a second mortgage essentially means that you have two different loans secured to the one property.
A second mortgage is paid off in the same way as a primary one, with the borrower making repayments at agreed intervals, typically in fortnightly or monthly instalments.
Why might you take out a second mortgage loan?
There are a number of possible reasons you might want to access the equity in your home, including:
- undertaking a home renovation project
- acting as a guarantor for someone else’s loan
- freeing up funds to purchase an investment property
- paying off student loans.
What should you be cautious about with a second mortgage?
If you are considering a second mortgage, it pays to understand exactly what you’re signing up for, and the potential pitfalls:
Higher fees and charges
Lenders tend to view second mortgages as riskier than first ones, as they are second in order of priority. In the event of a default, the lender behind the second mortgage will only receive funds from the sale of a house after the primary lender has taken what they are owed, with the owner receiving any remaining proceeds. For this reason, interest rates and fees associated with them are typically higher.
Fees from your primary lender
Likewise, if you decide to apply for a second mortgage with another lender, your primary lender will need to consent to this. It’s worth noting that if it does agree to this, it will typically charge an administration fee.
Budgetary considerations
It’s also worth keeping your own budget in mind. Taking out a second mortgage will mean paying off a separate loan in addition to your primary one. It’s worth considering your capacity to make repayments on a second mortgage, and whether this will lead to any financial stress, particularly amid cost of living pressures.
Tougher lending criteria
Whenever banks or financial institutions lend money, your financial position and your ability to repay the loan will be key considerations when deciding whether or not to approve your application. Lenders may be stricter in their assessment of your finances if you apply for a second mortgage as they will want to be confident in your ability to repay the loan.
Can you use a second mortgage to purchase an investment property?
Yes, some people may take out a second mortgage in order to fund the purchase of a second home or investment property. Here’s an example of how this might work:
Say your home is worth $800,000, and you have $300,000 remaining to pay off on your mortgage. Your equity in the property is $500,000. However, lenders usually won’t let you borrow this full amount.
To calculate your usable equity, take 80% of the property’s market value and subtract your current loan balance.
In this scenario:
- 80% of $800,000 (your home’s value) is $640,000
- $640,000 - $300,000 (the balance owing) is $340,000
- Therefore, your usable equity is $340,000.
That $340,000, if borrowed against via a second mortgage, could be used to fund the deposit on an investment property.
There are potential risks involved in this strategy though, because a downturn in the housing market could reduce the value of one or both of the properties.
When the market value of your property is lower than the balance remaining on your home loan, you are in negative equity.
Is it easy to get a second mortgage?
Because a second mortgage is second in priority to first mortgages, lenders may consider a second mortgage loan to be riskier, and you may find it harder to find a lender willing to approve one.
Say you already have a mortgage with Lender A, and you take out a second mortgage with Lender B. If you fall behind on your repayments, Lender A is entitled to be paid firstIf Lender A sells your home to recoup what it’s owed, Lender B will only receive whatever amount is left over.
It’s for this reason lenders may be more cautious when offering second mortgages.
If you find a lender willing to offer one, it may impose strict conditions and high fees. It may also only be willing to loan you a limited amount.
What are some alternatives to a second mortgage?
One of the main alternatives to taking out a second mortgage would be to refinance your existing loan.
Refinancing is typically a more straightforward process than taking out a second mortgage. Whereas a second mortgage involves taking out another loan (typically with another lender), refinancing involves approaching your existing lender and varying the terms of your current loan or switching your mortgage to a different lender.
One of the main advantages of refinancing over getting a second mortgage is simplicity–you only have one loan to pay off instead of two, and you only have one mortgage on your property. Refinancing can also allow you to save money if it allows you access to lower interest rates.
If you wish to free up some of the equity in your home, then you might be looking for a cash-out refinance.
A cash-out refinance typically sees you agreeing with your lender to replace your old home loan with a new one with a higher principal balance than your existing loan.
What are the pros and cons of a second mortgage?
Potential benefits of taking out a second mortgage
- Access to your equity: A second mortgage lets you turn your (usually) illiquid asset into usable cash.
- More choice: A second mortgage can give you access to cash for a variety of purposes, from undertaking a home renovation project to purchasing an investment property.
Potential downsides of taking out a second mortgage
- Higher fees and charges: The interest rates and fees associated with second mortgages are typically higher than on traditional home loans.
- Fees from your primary lender: If you choose to take out a second mortgage with a different lender, your primary one will typically charge an administration fee of a few hundred dollars.
- Budgetary considerations: It’s worth carefully considering your capacity to make repayments on a second mortgage, and whether this could lead to financial stress.
- Tougher lending criteria: Lenders may be stricter in their assessment of your finances if you apply for a second mortgage, as they will want to be confident in your ability to repay the loan.
Where can you get a second mortgage?
Depending on your needs and circumstances, if you are thinking of applying for a second mortgage, it may be worthwhile speaking to your existing home loan lender about refinancing your existing loan first.
Given the nature of second mortgages, many lenders may be hesitant to offer them. For this reason you may choose to contact a mortgage broker, who may be able to assist you.
