Can I take a second mortgage for home improvements?

Most Australians take out a mortgage to buy their first property. While the home loan covers the purchase price of the property, you may find yourself in a situation where you need additional funds to cover renovations.

In this scenario, some owners utilise offset or redraw facilities, while others may consider taking a second mortgage. People may choose to take on a second mortgage for a number of different reasons, including for home renovations.

After repaying a home loan for some time, you may gradually build up equity in your home, which is the difference between the value of your property and the balance on your loan. You may be able to use the equity you’ve accrued as security for a new loan. 

While a second mortgage may be advantageous for some, it’s not the most sensible choice for every homeowner needing to finance their renovations. Therefore, it's essential to understand the advantages and disadvantages of applying for a second mortgage before deciding it’s right for you.

What is a second mortgage?

As the name suggests, a second mortgage is a subsequent home loan in which you offer your home as collateral or security. The purpose of a second mortgage is to access additional funds using the equity in your home, but these loans can attract higher charges and there are additional risks involved that need to be considered.

If for some unfortunate reason you are unable to repay what you owe and your house needs to be repossessed and sold, then the first mortgage will be paid in full first and repayments for the second mortgage will be remunerated from the funds that remain. For this reason, some lenders may not offer the option of a second mortgage, as the risk for both you and the lender is higher than a traditional mortgage.

In order to secure a second mortgage, you may need to consult your existing lender as they must consent to the second mortgage, even if you wish to take it out with another lender. A second mortgage can be an option if you have already tried to borrow more as part of your existing mortgage but have been refused by your lender.

Many borrowers opt to refinance or source alternative financial solutions to taking out a second mortgage. When you refinance, you may be able to borrow an additional amount from the same lender, possibly at a lower rate of interest. However, some homeowners may feel they can get a better deal if they use the equity in their home for a new loan. 

The term second mortgage usually refers to a loan where you borrow a lump sum. A home equity loan is similar but could be offered in the form of a line of credit, like a credit card linked to your home equity.

Funding home renovations using a second mortgage

Whether you’re renovating to sell, or looking to grow your home’s long-term value, renovating certain areas of the home could provide a much bigger return on investment. If a property has major underlying issues, such as problems with mould, damp or rot, you may want to prioritise fixing these over giving the place a cosmetic makeover.

A potential advantage offered by a second mortgage is that you can borrow at today's interest rates, which may be lower than your current rate. However, this is not always the case. You can also avoid some of the potential pitfalls of refinancing, such as exit fees and negotiations. 

However, there are certain disadvantages to a second mortgage. Many banks do not favour them, mainly because the risk to the second lender is significant. As a result, their interest rates and fees for such a loan could be high. The processing time for a second mortgage may also be longer than that of standard home loan products.

Lenders offering second mortgages are likely to offer smaller loan amounts given the increased risk they carry. Usually, you cannot borrow as much from a second mortgage as from a first mortgage, which often means you’ll need a higher deposit. You’re also only likely to be approved if your home has sufficient equity. You should confirm that your home’s market value is higher than the price you bought it for before applying for a second mortgage.

It may be worthwhile speaking to different lenders to find out the terms they might offer for a second mortgage for home improvements. After considering their fees, examine how a second mortgage compares with alternative options, such as refinancing, while taking into account any extra fees and charges you may incur.

You may wish to consult an experienced mortgage broker who can help you compare the benefits and costs between a refinanced loan, home equity line of credit, or second mortgage.

Financing alternatives for home renovations

If a second mortgage isn’t preferred there are other options you may choose to consider to cover your costs.

• Withdrawing money from your mortgage offset account
• Redrawing extra repayments from your home loan
• Refinancing your mortgage to get a top up
• Accessing your home’s equity to take out a line of credit
• Taking out a home improvement personal loan
• Applying for a construction loan (often more for large-scale projects, such as building a new home)

Remember that it’s possible to “overcapitalise” a renovation project by spending more than the amount it would increase your property’s value by. If you’re renovating to sell, overcapitalising could mean effectively losing money. Doing some research into property values in your area could help you get a better sense of perspective when planning your renovation project and setting your budget.

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