Looking for a clear second mortgage example to help you understand second charge mortgages? You just found it!
MoneyNerd brings you this new guide to clearly explain what second mortgages are and how they work in practice. Read on for a second mortgage example and answers to common second mortgage FAQs.
What is a second charge mortgage?
A second mortgage is when a second mortgage is taken out on a property with the initial mortgage still in effect, i.e. not fully repaid. Whereas the first residential mortgage is secured by the property, a second charge mortgage is secured with home equity, meaning the size of this second mortgage is determined by the equity as well.
The homeowner would need to pay two monthly mortgage payments to clear the mortgages, which could be with the same or different lenders. The advantage of getting a second mortgage rather than extending your loan with a remortgage is that you could avoid early repayment fees.
Interestingly, sometimes a second mortgage is also used to refer to any further mortgages added to a property, such as a third mortgage. However, instances of this are quite rare.
What is home equity?
To fully understand a second mortgage and to follow the second mortgage example below, we must first explain what home equity really is.
Home equity is a term used to refer to the amount of your property that you own outright with no existing debt. It can be shown as a financial sum or a percentage. This is worked out by subtracting all debt on the property (usually just one mortgage) away from the value of the property.
For example, owning a home worth £230,000 with an existing mortgage of £150,000 leaves £80,000 equity in your property (£230,000 – £150,000).
What is an example of a second mortgage?
A second mortgage is when a homeowner takes out another mortgage on their property using their home equity as collateral. Our second mortgage example explains this best:
Let’s imagine Eric has a property worth £300,000 which has not changed in value. He bought the property a long time ago and only has £50,000 left on his mortgage to pay, leaving him with £250,000 home equity.
Eric needs credit for a big purchase and decides to take out a second mortgage on his property using his home equity as security within the mortgage. Eric needs £70,000 and uses a new lender to give him a £70,000 mortgage, which he begins paying back separately from his first mortgage.
Because he is leveraging home equity, some people consider a home equity loan or home equity line of credit as a type of second charge mortgage.
If Eric loses his job and is unable to pay his mortgages, the property may be repressed and sold. The initial mortgage lender will take the property and sell it. The money raised from the house sale will first be used to pay the debt he owes to them. In other words, the first mortgage lender gets priority.
Any remaining money from the sale will be used to repay the second mortgage debt. And any further money left will be Eric’s.
Do you pay interest on a second mortgage?
You have to pay monthly interest on a second mortgage just like you have to pay interest on your first residential mortgage. The interest rates offered on second mortgages are typically much higher than the interest rates offered on first mortgages. There are many reasons for this, including:
- The second lender does not get priority over the first lender when trying to recover the debts after defaulted payments and foreclosure.
- The first mortgage probably means you now have more debt
- Your lending risk will have increased
What are second mortgages used for?
Second mortgages can help homeowners access big loans that they probably cannot find on the rest of the loan market. Getting access to this amount of cash could fund life-changing purchases and experiences. Second mortgages are often used for home renovations (conservatories, loft conversions, new kitchens etc.) and debt consolidation.
But they’re also commonly used to pay for :
- Private education or university courses
- Private medical procedures
- Holiday home
- Cars and holidays
- Property for (younger) family members
How much can I borrow with a second mortgage?
The amount of money you can borrow with a second mortgage will be first determined by your home equity. Once you have calculated your home equity, lenders will usually allow you to borrow up to 90% of this through a second mortgage.
The more you borrow the longer it will take to pay off both mortgages and own your property without any existing debt.
Furthermore, borrowing against large amounts of equity increases the danger of getting into negative equity. This is when the property value decreases and you end up tied into paying more for the property than it is worth. If you fail to keep up with repayments the sale of the home won’t cover your debts and could lead to bankruptcy.
Overborrowing is one of the biggest pitfalls of getting a second mortgage.
How to get a second mortgage
Second mortgages are available through most mortgage lenders, namely banks and building societies.
You can search your options online and compare deals using the representative APR. However, the mortgage deal you are offered will depend entirely on personal circumstances. Your income, debts, credit score and other financial information will be assessed by the lender. Simply having home equity is not enough to get a second mortgage. It can be harder to get a second mortgage than a first mortgage.
Only apply to lenders that are authorised and regulated by the Financial Conduct Authority (FCA).
More second mortgage FAQs are answered here!
Additional information for second mortgage seekers is available through MoneyNerd. Now that you fully understand a second mortgage with a clear second mortgage example, it’s time to dive into some of the other details.
Read more on our blog about how to get a second mortgage and the key considerations!