A second mortgage is simply a home loan taken out on a property that is already mortgaged. This means you will have not one, but two home loans secured to your property. An arrangement such as this allows you to access additional funds; however, it is not regarded as a suitable financial solution for everyone.
When and why is a second mortgage needed?
If your existing lender has refused your request to borrow a larger loan amount so that you can access some of the equity in your home a second mortgage home loan could be a viable alternative. In addition, if you currently have a fixed rate home loan and you want to refinance you could be hit with expensive exit fees if you try to change provider, so taking out a second home loan may prove more helpful.
Some parents have taken out a second mortgage when they wish to act as guarantors and use their home as security for a family member’s home loan, or that of a friend. Having a second mortgage in this case also gives the bank additional security in the event that your family member or your friend, for some reason, default on their loan.
How do second mortgages work?
Unlike your first mortgage, your second mortgage works differently. It resembles having a line of credit as the money in this loan is drawn from acquiring equity in your property. In effect both home loans use your property as security. Your first mortgage will always take priority and your second mortgage is therefore ranked behind it. If you should default on your payments then your first mortgage will be repaid before your second one. If the property is sold and there are insufficient funds to pay both mortgages, your first mortgage will still be paid in full and the rest will go towards the amount owed on the second mortgage. Unsurprisingly, this is one of the reasons why it is much harder to find a lender willing to lend you a second mortgage as opposed to a first one.
One extra important point to remember is that you must seek permission from your existing home loan provider in order to meet the application criteria for a second mortgage.
What are the risks and rewards?
The benefits you can receive from a second mortgage are:
- Extra cash to allow you to take care of home repairs or renovations;
- Help towards consolidating your debts;
- The ability to access the equity in your home;
- The capacity to act as guarantor for a friend or family member.
Among the drawbacks and the risks are:
- Difficulty identifying a lender willing to advance further funds, as many are cautious about second mortgages;
- Failing to manage both loans effectively and risking defaults or late payments;
- Higher fees if you are granted your second mortgage because of wary lenders;
- Increasing your level of debt, potentially undermining the affordability of repayments;
- Lower allowable loan to value (LVR) ratios than with your first mortgage.