Comparing first and second mortgage terms in Australia
Getting the best deal possible for your private loan
Understanding the position of the second mortgage lender is important if you wish to acquire the best deal possible for your second mortgage loan, for business or investment purposes.
Knowing how to de risk your own private loan, will help you secure the best terms possible.
When comparing first and second mortgage private loans in Australia, it is important to realise that the second mortgage private lender is taking on more risk than the first mortgage lender.
Firstly, the second mortgage private lender ranks behind in security to the first. Secondly, the second mortgage private lender has less of an equity buffer available to them, should things go wrong!
Fundamentally this means in a worst-case scenario, should a lender need to take possession of an asset, if a loan went bad, the second mortgage holder is at the mercy of the costs of the first mortgage holder.
This substantially increases the risk for the second mortgage holder.
Because the second mortgage lender is taking on more risk, the pricing is higher (risk reward ratio) and their debt covenant terms will likely be stricter.
Interest rates for Australian second mortgages
As a rule of thumb, interest rates in Australia for private second mortgage loans are 1.5 to 2.5 times the cost of a first mortgage private loan. If first mortgage rates are at 10% p.a, you can expect the second mortgage rate to be between 15% and 25% p.a.
Loan to valuation ratios of second mortgage loans.
Second mortgage lenders in Australia will go up to 75% to 80% of the LVR inclusive of fees paid in advance. What this means, is that if the first mortgage on a property is at 60% of the LVR, they can provide another 20% on top.
Lets look at two different scenarios as an example.
A private second mortgage loan, behind a private first mortgage.
In the private lending market, first mortgages loans will go up to 65% to 70% LVR. So the pricing for the first 65% of the LVR of the loan, will have first mortgage rates. Anything above 65% up to 80% LVR will be calculated at second mortgage rates, even if it’s with the same lender (some lenders will offer a discount). The higher the LVR the more risk for the lender.
A private second mortgage loan behind a bank.
Suppose you have a bank loan at 50% of the LVR, but the bank won’t lend you more money. The second mortgage loan will fall behind the bank, and the second mortgage loan can provide up to 80% LVR, so an additional 30% of the LVR. Despite the bank loan being under 65% LVR, the second mortgage lender still falls behind a first mortgage holder (the bank), and rates will be at a second mortgage rate, but discounted for the portion under 65% LVR.
Second mortgage scenarios in Australia lending.
Reasons for choosing second mortgages in Australia
There are several reasons and scenarios as to why a borrower would opt for a second mortgage in Australia. It is important to remember that second mortgage loans are for short to medium term purposes only. They help fill a short-term liuquidity gap, but they aren’t a long-term solution. Most business owners that opt for a second mortgage loan do so because of how easy it is to get funds, versus dealing with their bank.
Below are several scenarios where you may opt for a second mortgage loan.
The bank won’t lend you more money.
Banks are notorious for not helping business owners when they need funds the most. This might be due to Serviceability, debt ratios, bad credit scores and missed interest payments, these are just a few reasons banks won’t provide funds. Consequently, when businesses need funding and banks are unwilling, businesses will resort to second mortgage loans.
Requiring urgent business funding
Businesses that need funds quickly, that can’t wait for a bank to provide funds, will often resort to second mortgage loans. This is because the inconvenience solved or opportunity gained by the immediate provision of funds, is greater than the cost of a private loan.
Equity release
Whether the first mortgage is with a bank or a private lender, second mortgage loans in Australia are typically used to release further equity out of an asset. This is critical if a borrower needs funding for business purposes, is looking to purchase an investment property or do a property development.
Second mortgage mechanisms for equity release
Generally speaking, there are two methods by which equity in an asset is provided to a borrower using a second mortgage loan
Cash via a second mortgage private loan
Second mortgage loans can release equity in asset, by proving that equity in the form of cash to a borrower. Providing the total principal amount and costs do not exceed 80% LVR .
Equity release using cross collateralisation
Firstly, if you aren’t familiar with the term cross collateralisation, it is basically where a lender takes security across several assets, and releases equity from each asset to provide a loan. This also helps to reduce the risk to the lender.
This is a common method when a property developer, or business owner wishes to extract equity from one asset, and to put that equity towards the purchase of another asset, whilst also taking a loan against the second asset.
Australian legal impacts on second mortgages
Responsible lending laws are different
There are several regulatory implications for private lending in Australia. The main feature of second mortgage private loans, is that they fall outside of the National Consumer Credit Protection Act 2009. These loans are strictly for business and investment purposes only! They are not for consumer purposes.
By taking these types of loans, a borrower is opting outside of the protections of the credit protection act. This requires borrowers, who are businesses or investors, to take a greater degree of responsibility when taking a loan.
Legal advice for second mortgages
Because second mortgage loans are more expensive than a first mortgage loan, most private lenders perform greater due diligence. This requires borrowers to take independent legal advice and may require a borrower to confirm they have taken independent financial advice as well. Second mortgage lenders will also perform greater DD regarding the exit strategy of the loan.
Real estate trends affecting second mortgages in Australia
Borrowers looking to take a second mortgage in Australia, should realise that the Australian property market and its direction could impact their second mortgage loan.
Depreciating property markets and second mortgages
In a depreciating real estate market, the value of a property will decline, thus reducing the equity available for a second mortgage loan, and this will also limit the size of any facility.
The other thing borrowers must consider, is that if a borrower already has a second mortgage loan and they have to sell in a deprecating market, this could reduce the total profits they get on crystallisation of the sale after paying all debt off.
In such markets it may not make sense to take a second mortgage.
Appreciating property markets and second mortgages
In an appreciating property market, the value of equity in an asset will grow. This allows for a borrower to access more equity in their property and increases the loan size. It may also encourage a second mortgage loan, as the equity growth may pay off a greater portion of the financing costs of the second mortgage. It also allows for greater profits, after the asset is sold off and all debts have been paid off.
Risk management for Australian second mortgages
There are several things’ borrowers should do to mitigate their risk when taking a second mortgage private loan. There are macro and micro factors that should be taken into consideration.
At a high level, there are economic considerations for them taking a second mortgage in Australia. Such as what is the overall direction of the property market as this will affect the equity in their assets. What is the overall economic direction of their industry?
Then there are the micro factors that need to be considered. What is the capital being used for? Is the return on second mortgage capital greater than its cost, or does the capital solve for a problem that is greater than a cost? Is their business still relevant, are they putting in good money after bad?
Some of these basic questions need to be asked and examined, before applying for a second mortgage loan.
If you'd like to read more about our second mortgage private loans that we offer, click here.
For a confidential discussion on your next second mortgage loan feel free to contact us.
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