Small businesses, given their limited resources, typically also have limited access to sources of information. Hence, it would not be a surprise if most small businesses are not aware of a fast, viable and accessible secured finance solution for them aside from the more usual (primary) mortgage loans and caveat loans. Yes, borrower, there is such a thing as a 2nd mortgage. And, yes, because time and timing can affect business operations, a 2nd mortgage loan can be a lifesaver.
Before we go any further, let us first review how lenders typically evaluate potential borrowers in order for business owners to understand how to navigate their businesses towards a positive loan approval outcome.
The 5 C’s of Credit
Banks or lenders typically look into the 5 C’s of Credit (character, capital, capacity, collateral, and conditions) when evaluating a credit relationship with a borrower. Bad credit puts a question mark on the first of those 5 C’s–character. However, there is a way to address this by enhancing one or more of the other discussed C’s, the easiest being collateral. Collateral is an asset offered by a borrower to the lender as security in a pledge of repayment of a loan. In the event of borrower default, the lender has the recourse to forfeit the pledged security in its favour as a form of repayment.
The acceptability of the security offered as collateral depends on the risk appetite of the lender. More conservative lenders tend to require more liquid instruments such as cash, cash instruments, marketable securities and such. On the other end of the spectrum, lenders could also provide financing to a borrower even without requiring security at all should the lender’s overall evaluation of the borrower suggest an acceptable credit risk. Somewhere in between that spectrum are loans secured by Real Property, that is, a piece (or pieces) of real estate that the borrower owns. There are two ways for the lender to secure a real estate property from a borrower: one, through a mortgage loan, and, two, caveat loans. They are both bound by an agreement wherein the borrower agrees to offer his/her real estate property (or properties) as a form of reassurance to the lender that he/she will repay the loan. Among the two, a mortgage loan is considered more secure.
How does a Mortgage work?
A mortgage gives a lender, usually a bank or other financial institutions, a right to repossess a certain property that was used as a security for a mortgage loan. In case a borrower defaults from paying off the mortgage, the lender in this case automatically gets the right of repossession over the property.
In mortgage loans, the lender most often takes the deed of the property and takes possession of it. This means that in order to legally encumber the said property. In order to remove a mortgage from the property, the borrower must be able to fully pay off the loan, and apply for the correct legal steps in having the mortgage attached to the deed removed.
Normally, when we talk about mortgage loans, it is understood to be a primary mortgage. This means that the lien or encumbrance on the property subject of the mortgage is in favour of the original lender. Not so commonly known are 2nd mortgages. These are loans taken against properties with existing (primary) mortgages. The term itself, secondary, explains that the obligation of the lender who accepts the 2nd mortgage agrees to be second in line to a lender who has the primary mortgage. In effect, a primary lender or mortgagor has the right to run after (or collect from the value of the mortgaged property or properties) the borrower’s obligations first before the 2nd mortgagor would be given a chance to do so.
Investopedia explains 2nd mortgages more clearly as quoted here under:
“A second mortgage is a type of subordinate mortgage made while an original mortgage is still in effect. In the event of default, the original mortgage would receive all proceeds from the property’s liquidation until it is all paid off.
Since the second mortgage would receive repayments only when the first mortgage has been paid off, the interest rate charged for the second mortgage tends to be higher, and the amount borrowed will be lower than that of the first mortgage.”
Given above, the question arises: why would a lender even agree to a second mortgage? I can think of at least three reasons:
- A second mortgage is still security. Loans under this method are still classified as secured, hence, a step better than unsecured.
- A lender can charge higher interest rates under a 2nd mortgage. Because of their nature, 2nd mortgages typically have higher interest rates than primary mortgages.
- A second mortgage typically has a shorter term than a primary mortgage. Generally, the shorter the term, the lesser the risk. A short term 2nd mortgage can be acceptable to lenders who prefer their loan portfolio to be short term.
The above reasons make it easier for lenders to say yes to small business borrowers in need of private business loans. Small business owners who need funding should keep these in mind when the urgency of financing requirements overtakes their need to save on interest costs. Urgency in this case can be as fast as 24 hours. While the fast approval process is enticing for businesses, it is important to remind the potential borrower to approach this option correctly and tap into it when the urgency of the financing is balanced by its importance for the business growth or continuity. Otherwise, losing sight of this could lead to a curtailment of their ability to repay the loan. And, the loan is tied to a second mortgage, it might also impact the ownership of the underlying real estate mortgaged.
A 2nd mortgage can be a fast, easy and accessible option over their primary mortgage. Fast 2nd mortgages to meet short term business requirements is only a matter of finding the right lender who will find your mortgaged property acceptable enough to grant the short term 2nd mortgage that matches your business needs.