Using a property as security on a loan may help you to access more money. However, you need to know the difference between a second mortgage and a caveat loan before you move forward.
You have plenty of options available to you if you need a loan for your business.
Many small businesses opt for short-term financing to help them out of tough spots. Those with long-term plans may go for traditional business loans.
However, you can also use any properties that you own to your advantage when looking for a loan.
A caveat loan can help you to pull your business out of a tight spot. However, many business owners confuse them with second mortgages. Even some lenders call their caveat loans second mortgages, which only adds to the confusion.
The problem here is that this misunderstanding can lead to a lack of clarity with your loan. You won’t understand exactly what the loan offers, which means you can’t maximise its use. Plus, you could end up in unexpected trouble due to the misunderstanding.
This article aims to shed some light on the situation. It will take a look at both loan types individually, as well as offering some pros and cons of each.
What is a Caveat Loan?
The confusion surrounding caveat loans becomes clearer when you look at their structure.
Like a second mortgage, it’s a loan type that requires you to use your property’s equity as security.
In the case of a caveat loan, you receive the money in return for the lender placing a caveat on your property’s title of ownership. This caveat prevents you from selling the property during the loan period. Furthermore, it prevents you from using the property as security on any other type of loan until you clear the caveat.
The caveat itself is actually a government-recognised document. It’s essentially a record of ownership that the lender lodges onto your property. It’s this document that sets the conditions for the entire loan.
Typically, the borrower receives their funds upon lodging the caveat. In return, the lender takes an equitable interest in the real estate asset. The key here is that this interest does not grant the lender primary ownership. However, it does give them the right to liquidate the property. This will only occur if the borrower defaults on the loan.
Other lenders can also see the caveat note. This makes it impossible for a borrower to secure further funding against the property while the caveat is in place.
With the caveat in place, the loan type works much like any other loan. You borrow money and repay it based on a pre-agreed schedule. Upon completion of the repayment plan, the caveat gets lifted and you can use the property as security on other loans again.
What is a Second Mortgage?
Much like with a caveat loan, a second mortgage is a loan that you take out on a property that you already own. This can be a property that you own outright or one on which you already have a mortgage in place.
Second mortgages differs from your first mortgage in terms of how it works. They allow you to draw the equity out of your property for use elsewhere. In this way, they work similarly to lines of credit.
Many use them to fund home improvements and other major purchases. However, business owners can use them to help with cash flow issues.
As this is a mortgage, you have to go through the same application process as you did the first time around. This usually means having the property valued and having a lender take a close look at your financial situation.
It’s important to note that a second mortgage does not supersede your first mortgage. You still have to repay that initial mortgage first. Once you’ve done that, you move onto repaying the second mortgage. That often means you can’t clear the second mortgage when you sell the property. You’ll usually have to pay a lump cash sum to end the loan in such cases.
Because of this, you’ll face tighter requirements when applying for a second mortgage than you did with your first. Lenders want to see that you’re able to keep up with the repayments and aren’t likely to default.
The Key Differences
As you can see, the loan types certainly have their similarities. Both use your property as security on a loan.
However, there are a few differences that you need to keep in mind too. With a second mortgage, you have to undergo a more rigorous application process. Your lender treats this loan type in much the same way as your first mortgage. However, they’ll often impose even harsher criteria on applicants. This makes the process more time-consuming, which may not be the best option for businesses that need fast access to funds.
By contrast, you can secure a caveat loan much quicker.
This comes down to the key difference between the loans. With a caveat loan, you can’t use the property as security on any other loan type. This makes things simple for lenders in case of a default. The caveat always takes priority.
With a second mortgage, the loan essentially stacks underneath your first mortgage. If you default, the first mortgage takes priority for clearance. The second follows. This is a more complex process, which is why it takes longer to secure a second mortgage.
Furthermore, caveat loans are short-term loans. You’ll usually have between 18 and 36 months to repay the loan. However, a second mortgage can last for several decades.
So, you get greater flexibility with a second mortgage. However, you receive quick access to funds with a caveat. Plus, it’s a much simpler loan type.
It’s also possible to remove a caveat, in the right situation. Maxiron Capital helped a client do just that. The client had purchased three properties, all of which had caveats lodged across them. By using one of those properties as security, Maxiron Capital helped the client to free two of the properties from their caveats. This provided them with the freedom to pursue other financial options using those two properties.
The Pros and Cons of Caveat Loans
Before choosing the right loan type for you, it’s important that you understand the pros and cons of each.
The following are the pros of caveat loans:
- The relative simplicity of the loan structure gives lenders more confidence. It’s usually easier and quicker to get this type of loan than a second mortgage.
- If you already own the property, it’s possible to borrow 100% of its value.
- The inability to secure other loans against the property with a caveat in place can help the borrower. It prevents you from making rash financial decisions based on using your property as security.
However, there are some downsides:
- You can’t secure any other loans against the property for the duration of the caveat loan.
- Assuming you’d borrow the same amount with a second mortgage, you’ll face higher monthly repayments with a caveat loan. This is because it’s a short-term loan. At best, you’ll have 36 months to repay the loan.
The Pros and Cons of Second Mortgages
Much like with caveat loans, second mortgages have their own pros and cons.
The following are the benefits:
- Second mortgages offer more flexibility than caveat loans. They do not prevent you from using the property as security on other loans. Of course, you’ll face stricter requirements for each loan that you try to secure against the property.
- You have more time to repay a second mortgage. Assuming an equal borrowing amount, you’ll spend less per month on a second mortgage than a caveat loan.
However, there are some drawbacks:
- The ability to keep borrowing against the property can lead to you over-borrowing. You could lose control if you’re not careful. If you default in this situation, you leave yourself in dire financial straits due to the need to repay multiple loans.
- It takes much longer to apply for a second mortgage. You’ll also face strict lending criteria. This puts them out of reach for people who have poor credit or those who need quick access to funds.
- You face similar fees as you did with your first mortgage when applying for a second mortgage. You may have to pay for a valuation, the closing costs, and the application itself.
The Final Word
There are plenty of differences between caveat loans and second mortgages. Don’t assume that they’re the same. Caveat loans offer much quicker access to funds. However, they come with more restrictions.
Maxiron Capital offers both loan types and we’re happy to help you choose the right one for you.
With our caveat loans you get the following:
- Funds within 48 hours of your application.
- The ability to borrow up to 100% of your property’s value (when combined with your business’ value).
- Flexible repayment options, including an instalment plan to help you relieve the burden of the final payment.
- No property valuation (in most cases).
- A maximum loan term of 36 months.
With our second mortgages you receive:
- The ability to borrow up to 100% of your loan to value ratio (LVR).
- A decision within five minutes of sending your online application.
- Easier qualification than you’d receive from a major lender.
All that’s left now is to find out if you’re eligible for either loan type. Apply with Maxiron Capital today to find out more.