What is a Third Mortgage?
A third mortgage is a loan wherein the principal provided by the lender is based on the value of the property and the equity that the borrower holds. Since this is the ‘third’ mortgage though, it is subordinate to the first two mortgages and comes in third position behind the second mortgage. This means that in the event of a default, the first and second mortgages will be paid off first from the proceeds of any potential power of sale, and the third mortgage lender will be paid off if there is enough available. However, it is also important to note that if a borrower does take out a third mortgage, they will be responsible for making the monthly payments all three mortgages at the same time. Should they sell the property, they will be responsible for paying off all three mortgages at the time of the sale.
How to Qualify for a Third Mortgage:
In terms of the criteria that lenders use to assess and evaluate your loan application for a third mortgage, they don’t differ vastly from other private mortgages, be it a private second mortgage or a private primary mortgage. Like with a private first or second mortgage, lenders will look at the appraised value of the house, credit history and score of the borrower, monthly and annual income, and the loan-to-value ratio of the property, however their main interest would be on the value, available equity, and the marketability of the home. They place the majority of weight on those factors much more so than on the borrower’s credit rating, creditworthiness, monthly cashflow, and debt-to-income ratios.
Another difference lies in the fact that with a third mortgage, a borrower is already leveraged (i.e. has undertaken a material amount of debt out secured against their home). To that end, these aforementioned metrics will be scrutinized a lot more closely to ensure that the borrower generates sufficient income on an ongoing basis to service the multiple mortgages that they presently have and/or are requesting.
Advantages of a Third Mortgage:
- Additional funds
With a third mortgage, the borrower is able to tap into the equity inside their property to gain supplementary funds that can be used for a range of purposes. Some borrowers may use this for tuition expenses, vacations, weddings, debt consolidation, etc. Others may use it to conduct home renovations and improvements that bolster the value of the property. Ultimately, the third mortgage, in the right situations, provides the borrower with additional financial flexibility and capital that they can use to pursue a range of other goals and dreams.
- Potentially large amount of principal
If a borrower’s home has risen exponentially over time, a third mortgage can be a solid option to gain a large amount of funds instead of dipping into existing savings or selling off other assets such as stock. Some third mortgage lenders will lend up to 85% and in some cases even 90% of a home’s value.
For example, take a house that was purchased at $500,000 and has $300,00 in remaining mortgage balances from the first two mortgages. This means that the current loan-to-value is sitting at 60%. Now imagine that this house’s value recently rose to $600,000. That means that at 85% loan-to-value, up to $510,000 can be mortgaged. This implies that the third mortgage can therefore be in a principal amount of up to $210,000.
Disadvantages of a Third Mortgage:
- Lesser options
Traditional lenders such as banks, trust companies, credit unions, and mono-line lenders do not provide third mortgages. Even institutional private mortgage lenders such as MIC’s and mortgage funds are hesitant to provide third mortgages since they are generally considered to be ‘riskier’ than a second mortgage. This is mainly because in the event of a power of sale or foreclosure, the first and second mortgages are paid off first before the third mortgage is paid off, and in some cases, there may not be enough remaining for the third mortgage lender to recoup all or even some of their principal investment. As a borrower, this means that you have less choices between lenders as opposed to a first or even second mortgage.
- Higher interest and fees
As discussed above, the higher level of risk involved for the lender means that they will charge a higher interest rate for the third mortgage compared to a second or first mortgage, along with higher lender fees to help make up for the additional risk that they are taking.
- Power of Sale or Foreclosure
Obtaining a third mortgage means that the borrower has to make three separate monthly mortgage payments and eventually pay off three separate sets of mortgage principal balances and interest. As such, if the borrower defaults on any of these payments, the home is likely to go into a power of sale or foreclosure scenario.
Is it too risky?
That brings us to the overarching question: is a third mortgage too risky? As with a lot of things in personal finance, the answer to that question is that it depends. Each borrower’s financial profile is different.
So before obtaining a third mortgage, assess your unique financial scenario including the income you generate, the existing debt load that you are carrying, the current mortgage balances from your first and second mortgage, and the prevailing market valuation of your home. If needed, talk to a mortgage broker before making the leap! And experienced and knowledgeable mortgage broker can help you with calculating all the costs and helping you determine if a third mortgage can help your financial situation or jeopardize it.