Financial Encumbrances: First Mortgages, Second Mortgages, and Caveats

If your clients have equity at their disposal and need access to additional funds for business purposes, then a second mortgage could be a viable option for them.

In this article we explain the key differences between mortgage types and their respective priority in financial obligations.

There are generally three types of financial encumbrances recorded on a Certificate of Title. These are first mortgage, second mortgage and caveat.

First Mortgage

A first mortgage is a first ranking charge over a real estate to secure monies loaned. This primary lien (secured against the real estate assets) takes precedence to all other mortgages and financial encumbrances on title.

If the property is sold or if the borrower defaults, the first mortgage is paid in priority before any other mortgage or charge on the property.

Second Mortgage

A second mortgage is subordinated to first mortgage. When registered, this is a legal instrument on title. Mortgages are ranked in order of priority. Any proceeds from an asset are paid to satisfy the first mortgage lender. Any surplus funds are applied to repay the second mortgage lender.

Caveat

A caveat is a form of statutory injunction to protect interest in land. Once a caveat is lodged, it restricts dealings on the land such as selling, transferring or even further encumbering the property. A caveat does not preclude a borrower from drawing down on any existing mortgage secured against the property.

Parties must have a caveatable interest to be able to lodge a caveat. Examples include being the holder of an easement or a debt in relation to the property.

Difference between Second Mortgage and Caveat

A mortgage is a legal interest in land. In some cases, when obtaining a second mortgage, consent of the first mortgagee is not required, but it is prudent to obtain this.

A caveat is an equitable interest in land. A caveat does not require consent from the first mortgagee. Whilst it may seem to be the path of least resistance, there are many limitations and risks associated with Caveats.

Most first mortgage loan agreements have a negative pledge clause. Under such clause, a borrower agrees not to encumber the asset with further debt without the consent of the first mortgagee. This means that the lodgment of any caveat (without consent of the first mortgage lender) would constitute the event of default.

How do you obtain consent for a second mortgage?

This broadly takes two forms.

Option 1 – Consent Letter from First Mortgage Lender

The first mortgage consents to register a second mortgage and states the priority (first mortgage) amount that is owed.

Option 2 – Deed of Priority

This document (also known as an inter-creditor deed) is a contractual agreement between the various creditors. The first mortgagee is generally referred to as the senior creditor and the second mortgagee as the junior creditor.

A Deed of Priority stipulates the relationship between the parties, their respective rights and the first mortgage priority amount.

Second Mortgage Suitability

In some circumstances a second mortgage is a palatable option. Examples are:

• Borrower has maximised borrowing capacity on their first mortgage facility (typically because of servicing constraints).
• Existing lender exposure is at capacity (borrower portfolio constraints).
• Short term bridging facilities where there will be continuation of the first mortgage debt.
• When the blended cost of capital (first and second mortgage) is lower than the first mortgage.
• When the break costs of the existing first mortgage is prohibitively high, rendering a first mortgage refinance not viable.

Vado Private Second Mortgage Facility

Vado Private offers a very competitive second mortgage product. Some of the key criteria and metrics we consider are outlined below:

• Second mortgage must be registered with either consent or Deed of Priority
• First mortgage lender must be a known bank or non-bank
• Residential, commercial, retail or industrial property are acceptable security
• Maximum loan amount of $1 million
• Loan terms up to 3 years
• LVR up to 70%
• No serviceability test or income declaration
• No minimum ABN period
• Investment and bridging loans
• Payment of ATO debts acceptable
• Residual stock acceptable security

For assistance

Vado Private provides bespoke financing solutions tailored to the specific needs of borrowers. We would love the opportunity to chat to you regarding any scenarios or questions. Please contact the Business Development team at Vado Private to discuss any opportunities on the details below, or you can submit a scenario online via our website.