What is a second mortgage?
A second mortgage allows you to borrow against your home equity to take out an additional mortgage on your property. Equity is the difference between your property’s value and home loan balance.
A second mortgage is an encumbrance (an interest held) on the property title in addition to your first mortgage (the initial loan you used to purchase the property). You don’t have to get a second mortgage from the same lender that issued your first one, and your second mortgage does not change the terms of your original mortgage.
To take out a second mortgage, you’ll generally need permission from your initial lender to register a second mortgage on the property title.
The reason for the second mortgage is key
Mansour Soltani , Money's home loan expert
“If the lender does not like the reason you want to take the second mortgage, and/or it does not fit their policy, then it doesn’t matter if they are the first mortgagee or not, it will be rejected.”
Mansour Soltani , Money's home loan expert
How does a second mortgage work?
When you take out a second mortgage, you essentially have two different loan amounts secured against your property. The second mortgage is ‘subordinated’ to the first mortgage. This means that in the event of a loan default, the lender that issued the first mortgage gets repaid first, before any money is paid to the second mortgage lender.
To get a second mortgage loan, you’ll need to have enough usable equity in your property — equity you can borrow against (as opposed to a cash deposit for your first mortgage).
Otherwise, a second mortgage works like a standard mortgage. You’ll borrow a lump sum from a lender, which you’ll repay with interest over a fixed term through regular repayments. It will be a debt alongside your first mortgage.
Features of a second mortgage
- Interest rates on second mortgages are generally higher than first mortgages, as they are considered riskier for lenders (i.e. the second mortgagee gets paid last if there’s a default).
- Because you’re using equity as security for the loan, your second mortgage will usually have a lower loan-to-value ratio (LVR) than your initial mortgage. Generally, the combined first and second mortgage cannot exceed an 80% LVR. That’s both loan amounts relative to the property’s value.
- Second mortgages are usually for smaller amounts and have shorter repayment terms (ranging from 10-20 years).
- Second mortgage loans have stricter eligibility requirements than first mortgages, which means not all lenders offer this type of product.
- A second mortgage loan typically offers similar features to those of a standard loan, such as an offset account, options for additional repayments, and a redraw facility.
How much could you borrow for a second mortgage?
Most lenders require you to maintain 20% equity in your home after taking out your second mortgage. Therefore, if you have 50% equity, you can borrow up to 30%, so that 20% equity will remain in the property.
Suppose your home is valued at $800,000, and your existing first mortgage balance is $400,000. Given the lender's maximum LVR of 80%, the calculation would look like this:
1
Calculate the total value you can borrow up to 80% LVR
Maximum total loan amount = property value × 80% Maximum total loan amount = $800,000 × 0.80 = $640,000
2
Calculate the current loan balance
Current loan balance = $400,000
3
Calculate the maximum second mortgage loan amount
Maximum total loan amount = $640,000 − $400,000 (current loan balance) Maximum second mortgage loan amount = $240,000
Therefore, you could borrow up to $240,000 with the second mortgage to maintain a combined LVR of 80%.
When can you use a second mortgage?
1. When acting as a guarantor
You may need a second mortgage if you act as a guarantor on a mortgage for your children or other family members. Some lenders (e.g. Bankwest, Commonwealth Bank) offer guarantor loans structured as two separate home loans: one secured by the property being purchased and another secured by a portion of your equity (usually just enough to reduce the LVR to 80%).
2. If you need an alternative to refinancing
There may be instances where refinancing your current loan doesn’t make financial sense. For instance, if you're locked into a fixed-rate loan and face high break costs, you might choose a second mortgage instead. Similarly, if you’re on a competitive fixed rate, you may opt for a second mortgage to maintain that rate.
3. To free up funds to buy an investment property
Some borrowers may take out a second mortgage to leverage their equity and buy an investment property or second home. There are some risks involved with this. If your property's value falls below the outstanding balance of both loans, this would put you in negative equity. This means you couldn't fully repay both mortgages by selling the property if it goes into default.
4. To free up cash flow for other expenses
You can take out a second mortgage to access additional funds for various purposes like home renovations, debt consolidation, pay off tax or student debts, or as a caveat loan (a business loan secured partially by home equity), for example. A second mortgage may have lower interest rates than a personal loan or credit card.
Pros & cons of a second mortgage
Pros
- A second mortgage allows you to leverage some of your home equity without selling the property
- You don’t have to change the terms of the first mortgage, which is ideal if you're already on a competitive rate
- A second mortgage may be cheaper than refinancing if you’re locked into a fixed loan term with high break costs
Cons
- A second home loan typically has higher interest rates, and you may pay extra fees for the lender to assess your request to add a second mortgage on the property title
- Taking out a second mortgage on your property will increase your debt, and you'll be making two separate regular mortgage payments instead of one
- Lenders generally have stricter eligibility criteria for a second mortgage loan than a first mortgage (i.e. they need to assess your ability to repay both loans)
How to apply for a second mortgage
Only a few lenders offer second mortgage products and those that go generally have strict lending criteria due to the reduced security position compared to a first mortgage.
There are two ways you could apply for a second mortgage:
1. Directly with a specialist lender
These are generally smaller lenders that offer alternative mortgages and non-conforming loans (e.g. low doc home loans, bad credit home loans). Keep in mind that specialist lenders tend to charge higher interest rates and risk fees. If you apply through a specialist lender directly, you’ll need to send all your income and property documents yourself. You may have to call a few lenders to ask if they offer second mortgage products.
2. Through a mortgage broker
A broker will typically have access to a panel of lenders that offer second mortgages. They will conduct a borrowing assessment based on the information you provide to suggest potential second mortgage products for your situation. A mortgage broker will generally handle the entire application process on your behalf from start to finish.
In either case, you’ll be asked to submit some supporting documents including:
- Proof of income, including two payslips for the year to date or two latest tax returns if you’re self-employed
- Records of living expenses, assets and liabilities
- Your current home loan statements
- A copy of your property title
The lender will need approval from the first mortgagee to register a second mortgage on the property title, and you may get pre-approval subject to this decision. The lender will need to confirm the maximum they can claim against the property in the event of default before a second mortgage can be added. Your new lender will conduct their own property valuation before granting unconditional approval.
Your lender may refuse a second mortgagee (lender) on the property to mitigate their risk. They may not want another party to have an interest over the secured property. One possible way around that is to get your second mortgage from the same lender as your first.
Second mortgage vs cash-out refinance: What’s the difference?
Second mortgage
- A second mortgage is a loan you get on top of your original mortgage. This means you'll have two separate loans with different interest rates and terms.
- With a second mortgage, you’ll make two mortgage repayments each month/fortnight/week.
- Second mortgage interest rates are typically higher than refinance rates because second mortgages pose a greater risk for lenders.
Cash-out refinance
- A cash-out refinance involves topping up your current home loan by borrowing against your home equity or paying off your existing mortgage with a new loan with different terms, and a higher loan balance. This lets you access some of your home equity as cash.
- With a cash-out refinance, you end up with a larger, single loan. You’ll make one single (larger) repayment each month/fortnight/week.
- Refinancing may be cheaper than taking out a second mortgage because you only pay one set of loan fees instead of two.
Not all lenders offer second mortgages
Mansour Soltani , Money's home loan expert
“Those that do often charge higher interest rates and impose additional fees to mitigate risk. We generally recommend cashing out equity over getting a second mortgage. The process is much more commonplace as long as the reason is legitimate and acceptable. Each lender has policies around cashing out equity and cash out limits.”
Mansour Soltani , Money's home loan expert
Is a cash-out refinance a better option than a second mortgage?
A cash-out refinance will usually be easier (and in most cases cheaper) than taking out a second mortgage. This is because:
- Lenders that offer second mortgages tend to charge a premium for the privilege
- It doesn’t require getting permission from your existing lender to add a second mortgage to the property title. Having a second mortgage means you’ll have two liens (legal claims) on your property and two debts to manage.
