Say you want to purchase a property but the first mortgage amount is insufficient. Or perhaps your less-than-ideal credits disqualify you from getting bank mortgages. Maybe you need some urgent money to help you get through a tough time. In those and other situations, some borrowers may consider getting a second or subsequent mortgage behind their first mortgage. What are some basic concepts you should know about when getting those loans?
What Constitutes Default
What constitutes “Default” is one of the most serious terms of a Mortgage Commitment. Simply put, it’s what you are supposed to do as borrowers, and also what you are not supposed to do. Commonly, you are supposed to make monthly payments to the lender, pay property tax, and maintain home insurance. You are not supposed to tear down or damage your mortgaged property. In addition to the standard charge terms, what may constitute default is also specific to each lender and the Mortgage Commitment that they require you to sign. In the event that you have defaulted in making mortgage payments, the lender may make the principal amount of mortgage immediately due in accordance with s. 7(1)1.ix of the Land Registration Reform Act. Also, as stated in s. 24 of the Mortgages Act, lender may start Power of Sale procedures, which involves taking away and selling your property to repay the loan after you missed three months of payments (aka. defaulted in payments). Nevertheless, usually you can stop this acceleration clause and the power of sale procedures if you pay back all arrears and expenses before the lender starts any claims or before the lender completes this sale of the mortgaged property.
So what’s different when you loan from a second or subsequent lender? One possible difference is that when you default under your first lender and your second lender finds out about this, then the second lender may choose to remedy the default for you. This may happen when you miss monthly payments to your first lender, then your second lender will use their funds to keep your first lender up to date, while informing you that you have now defaulted under the second lender.
Why would the second lender do this? Commonly, it’s because they want to control the Power of Sale process in case you no longer have the ability to pay back the mortgage and they must sell off your property in satisfaction of the loan. The second lender wants to be the one who sells the property, usually because first lenders will incur a high fee during the sale, so that there’d be less money left for the second lender when the property is sold.
How would the second lender know that you have defaulted under the first mortgage? Usually, the second lender will require you to sign an Authorization that allows them to obtain mortgage statements and information from the first lender periodically. Often, if you want that additional mortgage, you’d have no choice but to sign this document. Now, when this happens, it’s usually not good news for the borrowers, because the second lender’s mortgage interest is usually higher than the first lender’s. Hence, when the borrowers are in shock of discovering that they have now defaulted under the second lender, most second lenders will simply shrug and say it’s within their rights to keep the first lender up to date, and in most cases they are correct.
Usually second and subsequent mortgages have a term that is shorter than the first mortgage. When reviewing the Mortgage Commitment, it’s important to understand how long the term is, and whether there is an option to renew at the end of the term.
It’s important to understand the difference between amortization and term. Amortization is how the lender calculate the amount of your monthly payments. Term is the actual time the lender gives you to pay back your loan. Typically, the amortization period is much longer than the term. Simply put, amortization is comparable to minimum payments that the lender is allowing you to pay each month. This means at the end of the term, you will usually need a large lump sum payment in order to pay off the mortgage. Borrowers should be prepared to dish out this lump sum payment at the end of the term, or else the Borrowers may need to renew the mortgage (if possible) or seek other refinancing options. Otherwise, even if the Borrowers have been making monthly payments, not making this lump sum payment would likely result in the Borrowers being found in default.
When second or subsequent lenders offer a renewal option, it’s important to review whether there are conditions attached to the renewal. Some common renewal conditions include a higher interest rate or a shorter term.
In many cases, borrowers who are getting a second or subsequent mortgage are in a hurry to get this money in order to use the mortgage funds to refinance their property, to put money into their business, etc. However, borrowers should understand that the solicitor for the second & subsequent lenders must protect their client and complete due diligence. While the due diligence required differ from case to case, there are three common things that most solicitors will request.
First, the lender’s solicitor may require the borrower to put the second or subsequent lender as an additional loss payee on their Home Insurance. They require this because in the event that the property is destroyed, they’d use the insurance proceeds as security. It is important to check with your Home Insurance to see if this can be done. In most cases, you can simply call the insurance company and instruct them to add the new loss payee. However, some home insurances will put a cap on how many loss payees they can accommodate. From experience, we know some insurance companies will stop at three lenders as loss payees.
Second, the lender’s solicitor may require a mortgage statement showing the outstanding balance and showing whether you have defaulted with the first lender. Typically, the lender’s solicitor will request the statement themselves with your permission. This process may take from a few days to one week or two.
Third, sometimes there are security interests registered on your property. This typically happens if you purchased a furnace, air conditioning system, or a large appliance that you are paying off on a periodic basis. In those cases, some lenders may ask the security interest holders to postpone their interest behind the lenders’ interests. Again, this process may take some time, depending on the specific security interest holders.
Since getting second and subsequent mortgages are generally riskier than first mortgages, you will be more protected if you consult a lawyer before signing the Mortgage Commitment. Of course, recruiting a knowledgeable lawyer through the relatively different closing process will significantly reduce your stress during the mortgage transaction.