Understanding second mortgage loans!

Taking a top up loan on an existing home loan

Second mortgage loans or second mortgage financing, as the name suggests, means providing a loan against the security of a property which has already been mortgaged elsewhere. This means that the same property is being used for a second time to secure a new loan.

For example, Mr. X wishes to purchase a property for Rs. 50 lakhs in a suburb. He approaches Bank ABC for a loan of Rs. 40 lakhs (80% of the value of the property). In exchange, the property to be purchased is mortgaged in favour of Bank ABC. Now, subsequently after 3-4 years, if Mr. X wishes to borrow another Rs. 5 lakhs for the maintenance of the property, he can opt for a second mortgage loan. So he can mortgage the same property with another bank to borrow the amount needed. The second bank therefore takes a second mortgage loan on its books.

Normally a second mortgage means that the first lender has a priority over the asset mortgaged. So in the event of non-payment of dues, the first lender will realise his dues first, and only then the second lender will be able to realise his dues. However, a second mortgage can also be taken as a pari passu mortgage. This means, in case of a default by the borrower, the two lenders will share the rights in the property in accordance with the proportion of loans disbursed. In India, RBI has stated in its Master Circular on Housing Finance in July 2012 as follows, “In the case of individuals who might have raised funds for construction/ acquisition of accommodation from other sources and need supplementary finance, banks may extend such finance after obtaining pari passu or second mortgage charge over the property mortgaged in favour of other lenders and/or against such other security, as they may deem appropriate.” So this means that a second mortgage should be taken as a pari passu charge or an equal rights charge over the property.

When is a second mortgage loan usually opted for? The most common reason is the need for extra finance, to fund additions, alterations and repairs to the property purchased. The need for supplementary finance may not be met by existing sources or loans. There may not be additional security with the borrower to offer for a new loan. In such cases, a second mortgage loan can be useful.

Second mortgage loans are generally more expensive when compared to a first mortgage loan. This is because if the loan is not created with a pari passu charge, the risk of the second lender increases. In order to compensate for this increased risk, a higher interest rate is charged. When you think of a second mortgage loan, it is usually wise to enquire about this option first from your primary lender itself. This is because you may be able to get a lower interest rate when compared to interest rates outside, as you are an existing customer of the lender. However, if this is not workable, then you can approach other lenders for a second mortgage loan.

This product is available with leading lenders in the country. But your credit standing, repayment capacity and the value of the mortgaged property will be carefully ascertained by the bank before granting you a loan. As mentioned earlier, the risk is more, so the evaluation will also be stringent. Remember to inform your existing lender of this second mortgage loan.

What can be the possible drawbacks of a second mortgage loan? First and foremost, you are putting your property at risk for the second time. What we mean by this is that in addition to repaying your first loan, you are now carrying the additional burden of repaying another loan. So even if you default on any one of the loans, your property will be at risk. It is therefore critical that you make sure of the intended use of the funds borrowed in the second loan before you take the plunge. Second, as mentioned earlier, second mortgage loans have higher interest rate when compared to the first loan. Even if the loan is a pari passu one, the rates can be more. Again, add to this the processing fees and other charges of the new loan. Take into consideration all these expenses before opting for a second mortgage loan.

Evaluate how critical your need for the additional finance is and other funding options before you take a second mortgage loan. It is an additional liability on your books at the end of the day!