What is a second mortgage?
A second mortgage is an additional home loan that sits behind your first mortgage, using the house as security. When we say second, it refers to the loan’s claim on your property. The first mortgage has the primary claim, and the second mortgage is subordinate to it. This means if you sold the house, the first mortgage would be paid off first, and the second mortgage would be paid after that. Because the second mortgage lender is taking on more risk and because they are second in line to be repaid, second mortgages often come with higher interest rates than primary home loans.
So how much can you borrow with a second mortgage?
That depends on your available equity. Equity is the portion of your home you own outright, essentially the home’s market value minus any loan balances. Lenders typically require that the total of your first and second mortgage doesn’t exceed a certain percentage of the property value. In New Zealand, many lenders allow up to about 80% loan-to-value ratio (LVR) on an owner-occupied home, including all mortgages. For example, if your home is worth $800,000 and your first mortgage balance is $500,000, you have $300,000 in equity. In theory, up to $140,000 of that could be accessible and that would bring your total lending to $640,000, which is 80% of $800k.
A second mortgage is not the same as simply “topping up” your existing mortgage, though both achieve a similar goal of accessing home equity. A top-up means increasing your current mortgage often with your primary lender. A second mortgage, on the other hand, is a separate loan, and sometimes taken with a different lender. Second mortgages can be structured as a lump-sum loan, or loan with regular repayments, or even as a line of credit in some cases. Either way, your house is on the line as security.
Why Would You Get a Second Mortgage?
Homeowners consider second mortgages for a variety of financial reasons. Essentially, it’s a way to unlock the equity in your home. Here are a few common reasons to take out a second mortgage:
Home Renovations and Improvements
One of the most popular uses of a second mortgage is funding renovations, alterations or extensions on your home. Using your home’s equity to upgrade the property can be a smart move, especially if you are investing money back into your asset.
For example, you might add a new bedroom, modernise an outdated kitchen, or build an additional bathroom. Renovations and alterations can be costly, and a home equity loan can provide a lump sum to cover materials and contractor expenses. One advantage is that interest rates on second mortgages are typically lower than those on unsecured loans. In addition, well-planned renovations often increase your property’s value, sometimes immediately after completion, helping to offset the cost of the second mortgage through new equity.
Debt Consolidation
Some people use a second mortgage to consolidate high-interest debts. For instance, if you have several credit cards or personal loans, you could borrow against your home equity to pay those off. Then, you’re left with one loan (the second mortgage) which most likely has a lower interest rate and better payment terms. This can simplify your finances and reduce your overall interest costs. However, it’s important to be cautious with this approach as you’re converting unsecured debt into debt secured by your home, which means if you can’t pay it, your home is at risk. It only makes sense if you’re committed to not racking up those credit cards again, and you have a solid plan to pay down the second mortgage.
Major Expenses or Investments
Beyond home renovations and debt consolidation, a second mortgage can be used to fund higher education, starting a business, or purchasing an investment property. In the context of property investment, for example, homeowners sometimes take a second mortgage on their primary home to use as a deposit for buying a rental property. By leveraging equity, you can potentially grow your wealth, but of course, this comes with added financial responsibility and risk.
In essence, a second mortgage is a tool. If used for the right reasons, it can be very beneficial, allowing you to access large sums of money relatively quickly, and often at an interest rate far cheaper than personal loans. But like any tool, it must be used carefully.
Using a Second Mortgage for Home Renovation
You might wonder why not just use a personal loan or credit cards for renovation? Simply put, the cost and scale can’t always justify it. A major kitchen and bathroom renovation in a 4 bedroom 2 bathroom home can easily cost up to six figures and it is unlikely to get a credit card or personal loan with that high an amount. Beyond that personal loans in New Zealand usually carry high interest rates, often 14% or more. In contrast, a home equity loan leverages your property to allow a larger loan, and because it’s secured, the interest rate is much lower than otherwise.
When using a second mortgage for renovations, consider the following guidance:
Plan Your Budget
Get quotes for the work and build in a contingency for unexpected costs. Only borrow what you need and can afford to repay. Just because you have $200k of equity doesn’t mean you should automatically use it all.
Check Loan Terms
Work with a mortgage adviser to structure the second mortgage in a way that suits you. Some lenders offer interest-only payment options for a period (to keep payments low during the renovation), or you might align the loan term with when you expect to refinance or sell.
Ready to explore a second mortgage or need to fund home reno? Get in touch with Oliver at 0272 751 555 today for a free, no-obligation chat about tapping into your home’s equity. He will help assess your situation and talk through your options. Whether it’s a second mortgage, refinancing your existing loan, or some other route.