If you’re like most Australian homeowners, you probably took out a mortgage to buy your first property. While the home loan takes care of the big property purchase, you may find you need extra funds for renovations. In this scenario, some people turn to top up or redraw facilities, while others may consider a second mortgage.
After repaying a home loan for some time, you gradually build up equity in your home, which is the difference between the value of the house and the balance on your loan. A second mortgage is one of the ways to access the equity in your house as security for a new loan. While a second mortgage may be right for some, it’s not for everyone. Therefore, it's essential to know the pros and cons of a second mortgage before deciding whether this is the route for you.
What is a second mortgage?
As the name suggests, a second mortgage is a subsequent home loan in which you offer a house as collateral or security. If for some unfortunate reason you are unable to repay what you owe and your house needs to be repossessed and sold, then the first mortgage will be paid fully first and the second mortgage will be paid from the funds that remain.
Many borrowers prefer refinancing or topping up their loan to taking a second mortgage. When you refinance, you may be able to borrow an additional amount from the same lender, possibly at a lower rate of interest. However, sometimes people may feel they can get a better deal if they use the equity on their home.
The term second mortgage usually refers to a loan where you borrow a lump sum. A home equity loan is similar but could be in the form of a line of credit, like a credit card linked to your home equity.
Pros and cons of taking out a second mortgage for renovations
A major advantage a second mortgage offers is that you can borrow at today's interest rates, which may be lower than your current rate. You can also avoid some of the potential pitfalls of refinancing, such as exit fees and negotiations.
However, there are certain disadvantages to a second mortgage. Many banks do not favour second mortgages, mainly because the risk to the second lender is high. As a result, their interest rates and fees for such a loan may be fairly high. The processing time for a second mortgage may also be longer than that of standard home loan products.
It may be worth speaking to some lenders and find out the terms they offer for a second mortgage for home improvements. After considering their fees, look at how a second mortgage compares with closing your home loan and borrowing again, taking into account the exit fees.
You may wish to consult an experienced mortgage broker who can help you compare the benefits and costs between a refinanced loan, home equity line of credit, or second mortgage.