A second mortgage is a loan taken on a property on which you have already taken a loan. While this provides access to additional funds, it might not always be the right financial solution for all borrowers.
So before you decide to take out a second mortgage on your home, it’s recommended you learn more about how they work and the process involved.
How does a second mortgage work?
A second mortgage is when you apply for another loan against a property for which you’re already paying a mortgage. Usually, your second home loan is ranked behind your first home loan. This means that if you're unable to pay your mortgage and the property is sold; the first mortgage will be repaid before the second one. Thus, second mortgages are usually harder to get, and very few financial institutions offer them.
It’s important to note that you must seek permission from your existing lender before you can apply for a second home loan.
When should you consider a second mortgage on your home?
If you need additional funds, you may choose to refinance your loan to another lender instead of applying for a second home loan. However, there are some situations where a second mortgage may be a better option:
- Fixed rates on your first home loan: If your first home loan is a fixed-rate loan, you might have to pay high exit fees if you refinance during the fixed-rate term. In this situation, refinancing your home loan might not be the best option, and a second mortgage may be more beneficial.
- Guarantor support for your children: If you’re supporting your children to buy their first home, you could guarantee their loan using a second mortgage on your property.
Why should you take a second home loan?
Getting a second home loan might be a challenging process, but the benefits are often worth the effort:
- Consolidate your debt: By gaining access to additional funds using a second mortgage, you can work towards consolidating all your debt.
- Renovating or repairing your home: Additional funds acquired by applying for a second home loan may allow you to make much-needed renovations or repairs, potentially increasing the value of the property.
- Access equity: By applying for a second mortgage, you can access the equity of your house, enabling you to free up your cash flow.
- An alternative to refinancing: You can potentially avoid break costs, exit fees and other legal fees involved with refinancing by using a second mortgage as its alternative.
What are the risks of taking a second mortgage?
While there are multiple benefits of taking a second mortgage, you should be aware of the risks as well:
- Higher fees: Lenders tend to charge higher fees for second mortgages.
- Low LVRs: The loan-to-value (LVR) ratio is often significantly lower on a second mortgage. Typically, a lender will consider 60-80 per cent of the total property value, which may be higher if you use the same lender for both the mortgages.
- Higher debt: As you’ll be taking a second mortgage, you are taking on a larger debt. So, before applying for your second mortgage, ensure that you can manage the repayments.
- Confusion between two loans: Juggling the repayments of two home loans could be confusing, especially if taken from two different lenders.
- Selective lenders: A second mortgage is usually offered only by larger banks and lenders, limiting the number of options for you.
- Careful lenders: Lenders are extremely cautious when providing second mortgages as there is a higher risk to them.