A second mortgage is a second charge over a property that already has a mortgage.
Unlike the name suggests, a second mortgage is not used to buy a second property. Instead, a second mortgage uses the same property for security, but the initial mortgage is repaid first in case of default.
A second mortgage is usually taken out with a second lender. So, if you owe $250,000 on your first loan and have a second loan for the same amount with another bank, it is the first bank that will be repaid first in a worst-case scenario.
For this reason, second mortgages are deemed higher risk by the lender and will usually attract higher fees, charges and interest rates than first mortgages.
What is the purpose of a second mortgage?
You may contemplate taking out a second mortgage if you want to access the equity in your home. This could be for anything ranging from renovations to consolidating debts to a medical emergency. However, you would only take out a second mortgage with a new lender if your current lender has turned down your application to access your equity through more traditional means, such as refinancing, a home equity loan or a line of credit home loan.
There may be any number of reasons for needing to go to another bank for a second mortgage. The most likely reason is changes in financial circumstances that would make it more difficult to repay your current loan. This could be due to lost or reduced regular income. In some circumstances, it may make more sense to go with a refinancing arrangement with another lender.
How to get a second mortgage
Before you decide on a second mortgage, discuss all your options with your existing lender to see if you can make an arrangement. Failing that, you’ll need to examine your entire financial burden and whether you can service two mortgages simultaneously on top of your other commitments.
How much you can borrow will depend on the lender. Many are loath to offer second mortgages, given their inherently risky nature. Most will restrict the amount they are willing to lend you to between 60-80% loan-to-value ratio (LVR) as a way of minimising that risk. Some may offer more. Depending on how much you absolutely need, it may well be worth talking to a mortgage broker who has some expertise in this area. They can potentially draw on the products of a range of prospective lenders.
Another thing you can be reasonably sure of is that the lending criteria will be stricter than they were for your first loan. This will likely be reflected in the fees, charges and, more importantly, the interest rate.
Is a second mortgage a good idea?
- Access to funds. A second mortgage will provide you with funds you may not be able to obtain elsewhere. This is especially helpful if you’ve unsuccessfully tried to refinance or access your home equity via a home equity loan or a line of credit.
- Fixed rates. Suppose your first mortgage consists of a fixed-rate loan, and you must pay early repayment charges to refinance at the end of the fixed term. In that case, you may be better off getting a second mortgage with another lender in this scenario. Though, you’ll need to do some calculations first.
- Tax deductions. Taking out a second mortgage may have tax benefits because, in some circumstances, you can claim a deduction on the interest charged. However, once again, you should definitely talk to a financial expert, preferably an accountant specialising in property and investment.
- Tough lending criteria. One of the big drawbacks of taking out a second mortgage is the complex lending criteria that can make it difficult to apply. Many lenders will not want to take on the risk. So, you’ll need to be prepared to have your finances reviewed in minute detail.
- Financial stress. Taking on one home loan may be stressful enough. Two may feel like fighting a war on two fronts — especially if you’ve been struggling enough to require a second. Make sure you do your sums so you can actually afford the repayments. Also, remain wary of the pitfalls that could lead to mortgage stress.
- Complex application process. The application process for a second mortgage can be arduous and often involves liaising between two lenders and providing a large amount of paperwork with every conceivable detail about your finances. Eligibility requirements differ between lenders, so it’s important to compare your options. Once again, it pays to speak to a mortgage broker or someone with experience with the process to hopefully expedite it for you.
- Higher fees, charges and interest rates. The total cost of your second mortgage depends on the loan term, the amount borrowed, the LVR, the fees and charges, and, above all, the interest rate. By their very nature, second mortgages are very poor security for a loan. So, your lender has no guarantee they will get their money back in a worst-case scenario, as outlined above. The fees and interest rate are likely to be higher than for your first home loan. At the same time, a second mortgage may also attract settlement costs, appraisals, origination fees, title fees and other charges.
- Consent is required from the primary lender. Finally, obtaining a second mortgage is contingent on your current, or primary, lender’s consent. They will usually agree to this, depending on your financial circumstances. Still, they will often charge an assessment fee to review your request. As a rule of thumb, you should probably check with your current lender before spending too much time and effort applying for a second mortgage.