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What is a second mortgage?

A second mortgage is a loan taken out against a property on which you already have a mortgage. By taking out a second mortgage you have two different loan amounts secured against one asset. The second mortgage will sit behind your first mortgage.

The purpose of a second mortgage is to access additional funds using the equity in your home, but it can come with higher fees and there are additional risks involved that need to be considered.

The second mortgage uses your property as security, but follows your existing loan in priority. This means that if you default on your repayments and enter foreclosure, your first mortgage will be repaid before the second. For this reason, some lenders may not offer the option of a second mortgage, as the risk for both you and the lender is higher than a traditional mortgage. 

If your existing mortgage is worth $300,000 and you take out a second mortgage for $100,000 and cannot pay the debt, your property would be sold. If the property sells for $350,000 there is still a debt of $50,000 which won’t be covered. 

In order to secure a second mortgage, you also need to make agreements with your existing lender as they need to consent to the second mortgage, even if you wish to take it out with another lender. 

A second mortgage can be an option if you have already tried to borrow more as part of your existing mortgage but have been refused by your lender.

Is it easy to get a second mortgage?

Due to the additional risk involved, many lenders don’t offer a second mortgage option. The lower priority of the second mortgage puts your first lender in a position of higher risk than a traditional mortgage, or a refinancing, which can make them reluctant to approve. 

While some lenders won’t offer a second mortgage at all, others will put very tight limits on the amount you can borrow. Typically, higher fees will also be involved, even just for the assessment process. 

You will also need to have equity in your home to qualify for a second mortgage. The lender will require a valuation and the market value of your home will be used as part of the application process. 

The loan-to-value ratio (LVR) you will have access to will depend on your lender, but you may be able to borrow up to 95% LVR. Usually, a second mortgage taken out with a different lender to your existing lender will attract a much lower LVR.              

Most Australians who are looking to take out a second mortgage loan end up using a mortgage broker as the application process and lending criteria can be complex.

 Is it risky to get a second mortgage?

Taking out a second mortgage is riskier than one mortgage because it equals more debt. You will need to be able to afford the extra repayments and, as a general rule, there may be higher fees involved, which may cause a big hit on your finances. 

It’s likely you’ll also experience less choice for a second mortgage lender than a traditional mortgage, as many lenders are cautious about the additional risk involved and there are additional caveats. This can mean you end up with a high fixed rate and higher fees than you would usually agree to. 

If you do end up going with a second lender for the mortgage, you will also have access to a lower LVR than you would usually be eligible for.

Benefits and risks of a second mortgage

People take out second mortgages for a number of different reasons and there are a few things you need to consider before beginning the process. 

Pros of a second mortgage 

  • A second mortgage might allow you to access the equity in your home and unlock cash flow without selling the property.
  • A second mortgage may be an easier option than refinancing if you’re locked into a loan term.
  • You can use the funds you access to do a range of things, including renovations, covering unexpected bills or debt consolidation. You can also use a second mortgage if you're considering becoming a guarantor for a family member, or looking to purchase a second home.
  • The interest rates on a second mortgage may be lower than those on a credit card or personal loan, so it may work out cheaper in the long term than other financing options.

Risks of a second mortgage

  • A second mortgage is inherently riskier than other home loan options due to the level of debt involved and the final LVR.
  • In the event that you’re unable to make your repayments and your property has to be sold, it may not cover all the debt you owe, which will leave you with existing debt and no assets.
  • Second mortgages are likely to come with hefty fees and require some capital to pursue, even just in the initial payment your first lender will need to consider the option.
  • Limited choice means you may not be able to find an option with a lower interest rate or the features you want. It also means the process can be drawn out as you try to find a suitable lender and may lead to having to consider private lenders which isn't always a secure option.
  • Two mortgages mean your repayments will be much higher and this can take a toll on your finances.

Is a home equity loan a second mortgage?

Home equity loans and second mortgages are often used to describe the same thing, but they aren't always the same product. 

Essentially, your second mortgage will usually come in the form of a lump sum, while a home equity line of credit (or HELOC), is a line of credit tied to your home. This means you can borrow as much as is approved by your lender and only pay interest on the amount you end up accessing. Your lender will give you a drawdown period during which you’re allowed to access the additional credit and when this time is up you will pay interest against the debt you now have. 

A HELOC may allow you access to flexible repayment terms compared to a traditional principal and interest home loan, but can also attract more fees. HELOCs are often used as second mortgages.

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How does a second mortgage work?

When you take out a first mortgage, a lender provides you with a loan using the property you are purchasing as collateral. If you are unable to make the repayments you have agreed upon to the lender, the property will be sold, which is how that lender repays the debt you were unable to cover.

As you hold a property, the property's value may increase. The difference between the home’s existing value and your mortgage is equity. As that equity grows, a second mortgage allows you to access it without needing to sell the property. 

A second mortgage is taken out against the home equity, with the theory being that if you were unable to cover the second mortgage, the additional value of the property would cover both loans if you could not. It is paid out as a lump sum and is paid back on a payment schedule the same as a traditional loan would be. 

Because of the risk involved with a second mortgage, there may be additional eligibility criteria you need to meet before a lender will consider you.

Can you refinance a second mortgage?

You may be able to refinance a second mortgage, but each lender will have specific eligibility criteria you need to meet. This can make it hard to find a lender that matches your financial situation.

Can you get a second mortgage on an investment property?

You may take out a second mortgage against both a property you occupy and an investment property, but the eligibility may be even stricter for an investment property. An investment property carries additional risk for a lender, which is why they often attract higher interest rates than loans to owner-occupiers, so compounding that with the risk of a second mortgage means a lender will charge more. 

Some investors use second mortgages to fund the downpayment on additional investment properties, but this strategy brings the risk of losing everything if you cannot afford the repayments.

This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.