Is a second mortgage right for you?

If you’re already locked into a mortgage, the thought of a second one may seem daunting. A second mortgage certainly isn’t right for everyone, but is it the right move for you?

If you have equity built up in your home, it may be.

Before you can decide, though, you’ll need to know what you’d be getting yourself into.

So what is a second mortgage?

Your existing mortgage lender is already using your home as collateral against your loan. That means that if you have to default on your payments, they can sell the property and use the proceeds to cover their losses.

So how can it be possible to secure a second mortgage on the same property? After all, you can’t sell it twice!

The answer is, equity.

The way you calculate equity is by subtracting your existing mortgage from the value of your home.

For example:

Initial deposit: $60,000

Mortgage: $300,000

Value of home on purchase: $360,000

Amount of mortgage now: $280,000

Value of home now: $390,000

Equity: $90,000

You can think of it as your home’s untapped potential, or safety net.

If you offer that equity as collateral on another loan, the new loan is called a second mortgage. The new lender will have a claim over your property, but their claim will be secondary to the claim held by your existing lender.

How do you build up equity in your home?

There are two ways equity can build up in your house:

1. As you pay off your mortgage month after month and slowly reduce the principal. It can be quite a while before you make any real dent in your mortgage balance though, since you’ll be mostly paying interest during the first years.

2. If the market value of your property rises. Be wary, though, as market values can go down as easily as they go up. If you use your equity to finance a second mortgage and then the value of your property falls again, you could end up owing more on your home that it is worth.

How can I use a second mortgage?

Fees and interest rates on second mortgages are likely to be higher than you’re paying on your existing mortgage. That’s because, if you default, the second lender will have to wait until the first has recovered their losses. They are taking a bigger risk than the primary mortgage holder, because there may not be enough money left over after the sale to cover their losses.

These higher fees and interest rates mean you’ll have to pay more over the life of the loan. So it’s important to consider how you would use this influx of cash, and how quickly you can repay it.

Temporary loss of second income

If your family has unexpectedly lost a second income but is on track to re-establish a second career, taking out a second mortgage could be the key to keeping your family out of further debt. You could use the loan to pay any arrears on your primary mortgage, overdue taxes and debts, and help avoid unnecessary fees and penalties.

Starting a business

Taking out a second mortgage to finance a business venture can be risky. But it can also be much faster and easier than establishing finances for the business separately. This option will also mean that you don’t have to sacrifice shares of your company to obtain funding so all the profits stay in your pocket.

Renovating an investment property

Using personal property as collateral for an investment property can be a big cost reducer. NZ finance regulations mean that you’ll need a much bigger deposit for a loan on an investment property (35%) than for your private home.

To qualify for a traditional mortgage

You may even be able to use a second mortgage to offset the down payment you’ll need in order to get a traditional mortgage.

Mortgages in NZ are governed by regulations and lending standards that protect the long-term health of our economy.

That means that to qualify for a mortgage you’ll most likely need to have saved a deposit of at least 20%. And that if you can find a lender willing to let you borrow up to 90%, you’ll probably face much higher interest rates, plus expensive insurance that protects the lender if you default.

But let’s say you’ve found your dream home and you have only 10% of the down payment.

Using a second mortgage to cover the missing 10% could be the solution. It may enable you to qualify for a traditional 80% mortgage, and save the excessive fees, insurance costs and interest rates that would come with a 90% mortgage.

Conclusion

Taking out a second mortgage allows you to leverage the equity you’ve built up in your home. But you should seriously consider the risks involved in taking on additional debt, especially debt that is attached to your home.

Life does not always go as planned. While a second mortgage can be used as a bridge from financial hardship to stability, it can also create unnecessary financial burden.

As with any financial decision, it is important that you consider all factors and get advice from a finance professional to help you understand all your options.

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