If you’ve owned your home for long enough, you’re likely to have built some equity in it, giving you several options for financing your second home or rental property. For instance, you can leverage your home equity by refinancing your home loan for a higher amount, or take out a second mortgage using the same property as collateral.
What is a second mortgage?
A second mortgage refers to a home loan secured on a property on which you already have an outstanding loan. Typically, your second mortgage is ranked behind your first mortgage. This means if you’re unable to pay your mortgage and your property is foreclosed, the first mortgage will be repaid before the second one. For this reason, not many lenders offer second mortgages and those who do have stringent approval criteria in place. Furthermore, you also need approval from your existing lender before applying for a second mortgage. Note that your lender might charge an assessment fee for considering your request.
How much can you borrow with a second mortgage?
If you’re taking out a second mortgage for a rental property or any other purpose, you’ll first need to know the usable equity in your current property. This is usually 80 per cent of your property’s current value, minus the amount still owing on your mortgage. For example, if your unit is valued at $500,000, and you still owe $300,000 on your home loan, then 80 per cent of the value ($400,000) minus your outstanding mortgage leaves your with $100,000 in usable equity.
Your usable equity can help determine how much you can borrow for a second mortgage. A common estimate is the “rule of four”, where investors look for a property with a purchase price four times their usable equity - for example, if you had $100,000 in usable equity, you could look at properties priced up to $400,000. This would allow you to cover the cost of a deposit, stamp duty, and other upfront fees with your usable equity, and borrow the remainder.
For example, a 20 per cent deposit (necessary to avoid LMI) on a $400,000 property is $80,000, meaning you’d have to borrow $320,000. With $100,000 in usable equity, you could cover the cost of the deposit and have $20,000 left over to help pay for stamp duty and other upfront fees.
Is it a good idea to take out a second mortgage for a rental property?
Often people prefer to refinance their home loans rather than taking out a second mortgage, but it can be a viable solution in some cases. One such situation may be when your first mortgage is a fixed-rate loan, and there might be a high exit fee for refinancing during the fixed period. Alternatively, you might not want to refinance because your fixed rate is much lower than the ongoing variable rate. In this case, someone may choose a second mortgage to access additional funds using the equity built in the property. Some people may also consider a second mortgage to guarantee a family member’s property.
Whether taking out a second mortgage to access your home equity is a good option or not depends on your personal situation. A second mortgage can be helpful for raising additional funds using your home’s equity when you’re planning to buy a rental property. For instance, if your lender doesn’t approve a higher amount while refinancing, a second mortgage may be able to help. However, remember that buying a new property may impact your budget significantly, and it’s important to work out your cash flow by considering your total income, expenses and other debts.
Remember that if your application is successful, you’ll be servicing two mortgages, so you’ll need to convince the lender that your income is adequate to handle it. Once you buy a rental property, you may even look at adding a third mortgage into the mix. While the rental you receive may help ease your financial burden, you still have to cater for the periods when the house might be unoccupied. Speaking to an expert can help you put things in perspective and determine whether a second mortgage is suitable for you.