Second mortgages – what you should know and do

If you intend to make a loan that will be secured by a second mortgage over property, you should make certain enquiries and do a number of things to ensure those moneys will be adequately protected. Some of those enquiries and things are set out below.

Equity ‘buffer’

Before making any advances, you should satisfy yourself that there is sufficient ‘equity’ available in the property to adequately secure your interest.  That means, you will need to satisfy yourself as to:

  • the amount of moneys secured by the first mortgage over the property;  and

  • the value of the property, including on a ‘forced sale’ basis.

If the ‘buffer’ between the total aggregate amount secured by the first mortgage and your second mortgage and the value of the property is very small, there is a real risk that you will not recover all of the money owed to you under your second mortgage.  This can be as a result of, for example, arrears in repayments and default interest accruing on the loans secured by the first and second mortgages, a diminution in the value of the mortgaged property or both.

Priority agreement

You should enter into a form of priority agreement with the first mortgagee.  This agreement will typically contain provisions:

  • for the first mortgagee to consent to your second mortgage; and

  • that limit the amount of money the first mortgagee is entitled to be paid in priority to you.  The first mortgagee’s priority amount is typically expressed as a fixed amount plus interest, fees and charges payable under the first mortgage together with the costs of recovery.

If you do not enter into a priority arrangement with the first mortgagee, there is a risk that the first mortgagee may be entitled to be paid additional moneys under the first mortgage in priority to you, even in circumstances where those moneys are advanced after your loan is made.  This situation often arises in relation to construction loans where moneys are advanced in stages.

Make sure you examine the terms of any priority agreement carefully to ensure you know what the first mortgagee is entitled to be paid before you.  For example, if the mortgaged property comprises a number of separate properties, the first mortgagee’s priority limit will not always decrease by an amount commensurate with the sale proceeds it receives from the sale of part of the mortgaged property. The priority agreement may also contain subordination provisions which may mean you are restricted from being paid any money until all moneys owing to the first mortgagee are fully repaid.  

If you do not obtain the consent of the first mortgagee to the creation or existence of your second mortgage that will likely constitute a breach of the first mortgage.  However, that is a matter for the mortgagor and will not affect your rights under your mortgage.

Registration

You should register your second mortgage over the property in lieu of relying on a caveat to protect your interests.  A registered mortgage is more secure and effective than a caveat.  For example, you will not be able to exercise your power of sale to transfer the property to a third party unless your mortgage is registered.  Caveats are also at risk of lapsing notices a result of which you may need to obtain an order from the court to maintain your caveat over the property.  Caveats may be also be invalid and/or removed if not properly drafted.

If you do not register your mortgage or lodge a caveat over the property, the title will not show that you have an interest in the property.  Consequently, you may lose priority to a third party who does register a mortgage or lodges a caveat against the property to secure other loans or obligations.     

Conclusion

Having regard to the risks associated with second mortgages, at a minimum, we recommend you:

  • make proper enquiries to determine if there is sufficient equity available in the property to adequately protect the money payable to you under your mortgage.  As part of this, obtain confirmation from the first mortgagee of its secured exposure;

  • register your mortgage over the property;  and

  • enter into a priority agreement with the first mortgagee.

In all instances, however, you should seek appropriate legal advice to cater to your specific circumstances.

Further information

For further information please contact Kylie O’Keeffe, Special Counsel - Finance, on (08) 9288 6852 / kylie.okeeffe@lavanlegal.com.au.