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Second mortgage

The term second mortgage means secondary mortgage loan, i.e. a mortgage loan on a property that is already mortgaged for a loan. The secondary mortgage loan will be subordinate to the first mortgage loan, which means that in case of default and foreclosure, the lender of the first mortgage loan will get paid first, and the lender of the second mortgage loan will get paid next.

 

Example:second mortgage

  • In 1995, Property X is used as collateral for a $100,000 mortgage loan from Bank BBB. This is the first mortgage loan.
  • In 2000, the owner of Property X wants to renovate, and uses Property X as collateral for a $75,000 mortgage loan from Bank ZZZ. This is the secondary mortgage loan.
  • In 2003, the owner of Property X defaults on both loans. By now, he has paid down his first mortgage loan to $80,000 and his second mortgage loan to $70,000. The property goes into foreclosure and is sold. After transaction costs, there are $130,000 to be used to pay off the mortgages. $80,000 goes to paying off the first mortgage in full, and the remaining $50,000 goes towards paying off the second mortgage (but $20,000 is missing).

 

As you can see, the first mortgage lender (Bank BBB) has priority over the second mortgage lender (Bank ZZZ). Because of this, banks and other financial institutions tend to be more reluctant to approve a second mortgage loan, and it is not unusual for them to request a higher interest rate for the second mortgage loan than for the first one.

Alternative to secondary mortgage

An alternative to taking out a second mortgage loan is to increase the first mortgage loan. You can either do this with the original lender, or your can remortgage by borrowing enough money from another lender to pay back the original mortgage lender.

 

Example:

  • In 1995, Property X is used as collateral for a $100,000 mortgage loan from Bank BBB. This is the first mortgage loan.
  • In 2000, the owner of Property X wants to renovate, and applies to borrow another $75,000 from Bank BBB with Property X as collateral. This request is denied, so the owner goes to Bank ZZZ instead.
  • Bank ZZZ is willing to let him remortgage. He has paid down his original debt to $90,000 so he borrows a total of $165,000 from Bank ZZZ. $90,000 is used to pay off the original mortgage loan in full, and $75,000 is used for the renovation. Property X is collateral for the mortgage loan from Bank ZZZ. This is a first mortgage loan, not a secondary mortgage loan.