Using equity for working capital without refinancing

A bigger mortgage is not always the smart move

Owners with property equity often assume the way to free up cash is a refinance: swap the current loan for a larger one and keep the difference. That can easily be the slowest, most disruptive option available. The bank will want full financials, a fixed loan may carry break costs, and the process can stretch over weeks. If your current loan is cheap and well structured, surrendering it to get a modest sum is often a bad bargain.

There is another way: leave that loan exactly where it is and borrow behind it.

Ranking second, explained

Think of the title as a queue. The bank holding your first mortgage stands at the front. A second mortgage puts a new lender in the queue directly behind it, registered on the title. On a sale, the bank is repaid first and the second lender is repaid out of what is left.

A caveat loan puts the lender in much the same spot, except that it lodges a caveat on the title instead of registering a mortgage. Caveats can be in place faster and are popular for short terms, and if the loan ends up running longer, the caveat can be converted to a registered second mortgage.

Either way, your first mortgage keeps going untouched, and you keep paying it as usual.

How much a lender will advance

The lender adds what you owe on the first loan to the amount you want to borrow and measures that combined figure against the property’s value. Each lender sets its own ceiling on that combined ratio, and it moves with the type of property, where it is and how convincing the exit looks.

Before enquiring, try the second mortgage headroom calculator. Put in an estimated value, your current balance and a target combined ratio, and it gives an indicative figure for the room available.

Where this kind of borrowing earns its keep

Borrowing behind an existing loan works best when the need is genuine, has an end date and is tied to a clear source of repayment. Examples include:

• Paying a supplier early to lock in a discount or keep deliveries coming
• Carrying wages through the middle of a large contract
• Stocking up before the busy season
• Covering customers who pay on 60 or 90 days
• Putting down a deposit on new equipment or vehicles
• Paying off a tax debt before the ATO escalates

It is a poor fit for propping up a business that keeps losing money with no plan to fix it. Expect the lender to ask how the money will help and where repayment will come from.

Will your bank need to agree?

A lot of first mortgages include a clause saying no further security can be registered without the bank’s approval. Some banks consent as a matter of routine, some take their time and a few say no. A caveat may not need that consent, yet it could still put you in breach of the first loan’s terms. Check your loan documents or ask your solicitor, and read our guide to first mortgagee consent.

How the loan gets repaid

No secured loan should start without an exit. For working capital behind an existing mortgage, typical exits are:

• A planned refinance of both loans into a single facility once up-to-date financials are ready
• Selling an asset the business no longer needs
• Cash from trading once a contract or busy period pays out
• An expected tax refund, insurance settlement or grant

Many private loans let you prepay the interest or add it to the loan, so you may have nothing to pay monthly during the term. That eases cash flow, but the amount owing at the end will be larger, so build it into your exit plan.

Illustrative example

A cabinet-making business in Adelaide lands a big office fit-out that needs timber and hardware bought up front. The owners’ home is worth far more than the home loan on it, and that loan sits on a low variable rate they have no wish to give up. They take a twelve-month second mortgage behind it, with interest capitalised, covering materials and wages for the first three months of the job. Progress claims fund the later stages, and the second mortgage is cleared in full from the final claim and the release of retention.

This example is illustrative only and does not reflect any particular loan offer.

Before you sign, ask

• What will the loan cost in total over the expected term, establishment and legal fees included?
• Will interest be prepaid, capitalised or paid monthly?
• Is there any cost for paying it off early?
• What happens if the first lender changes its terms?
• What happens at the end of the term if my exit runs late?

Refinance versus borrowing behind

Set the two approaches against each other for the same need. A full refinance replaces every dollar of existing debt, may set off break costs on a fixed rate, generally needs complete financial statements and tax returns, and can take several weeks; it is designed for long-term restructuring. A second mortgage or caveat leaves your first loan alone, concentrates on the property and the exit, and can be organised quickly; it is designed for a specific need with a specific repayment source. Plenty of owners do both in turn, using a short second-ranking loan to fix today’s problem and refinancing later once the business has the paperwork a bank expects.

Taking the next step

If you have equity behind a current loan and a clear purpose for the money, check your eligibility. There is no credit check when you first enquire. We will ask about the property, what is owed on it and what the funds are for, and then set out your options.

It takes a couple of minutes to begin your enquiry.