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How mortgage brokers can protect themselves and find opportunities for borrowers BY RAY BASI, J.D., LL.B., DIRECTOR OF EDUCATION FOR CMBA-BC AND MBIBC
BROKERING A SECOND MORTGAGE
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nterest rates are on the rise. Borrowers in need of additional funds might want to add a second mortgage, rather than refinance the first and lose their existing favourable rate. Existing first mortgage lenders might welcome the borrower creating circumstances that entitle the first mortgage lender to call its mortgage due. How might a mortgage broker navigate these opportunities, best serve their borrower client, and best protect themselves? We will alert you to some of the issues. This is not intended to be legal advice. You should consider obtaining legal advice to cover specific situations and/or concerns. A broker may conclude that addressing the cautions expressed in this article would be impractical, disruptive or needless, and may result in borrower clients not proceeding with some transactions. The benefits, detriments and risks of following or not following the suggestions provided here is something each broker will have to assess. Regardless of the decision the broker makes, it is always better that the decision has been made with proper consideration of significant (and to some degree, unavoidable) factors.
The Borrower Client’s Request 1 A borrower asks you to arrange a second mortgage. This is a request commonly made of mortgage brokers.
Default triggered under the first mortgage While you are unlikely – at the time of the client’s initial request – to have seen the first
mortgage, you know that almost all mortgages contain a term to the effect that registering any further mortgage will amount to a default. The default generally gives the first mortgage lender the option to call for immediate repayment of its loan in full, by way of foreclosure proceedings if need be.
Incentives for first mortgage lender Most first mortgage lenders to date have not acted on the default created by the registration of a second mortgage. This may be because the existence of a second mortgage sometimes offers more protection for the first mortgage lender. For example, in a foreclosure action the first mortgage lender is entitled to payment in full in priority to the second mortgage lender receiving any funds at all and, in some cases, the second mortgage lender may protect its own interest by paying out the first mortgage lender. There are, however, sometimes incentives or reasons for a first mortgage lender to act on the default, and no broker should take comfort in a specific instance that the first mortgage lender will not do so. For example, the lender: n may make greater money on the transactional costs earned at the time loans are made (such as lender’s fees and brokerage fees) as compared to during the term of the mortgage. Accordingly, the lender may monetarily benefit from the early return and relending of the mortgage funds. n may conclude that the market has changed since the money was lent (such as interest rates having increased) and that the lender may benefit from relending money under the more favourable terms. n may simply have come to desire other uses for the funds (such as holidays, vacations,
For convenience, this article refers to the existing mortgage as the first mortgage and the mortgage to be arranged as the second mortgage. In fact, all mortgages, except the first mortgage, by their registration potentially breach then existing mortgages and accordingly raise the concerns discussed in this article. 1
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other investments, or meeting other obligations) and the default gives the lender the option of having the mortgage funds available early. n may find it unacceptable that the new mortgage causes the borrower’s earnings to cover more debts than had been presented to be the case at the time the first mortgage was granted. n may find it unacceptable that the borrower is, after granting the second mortgage, left with less equity in the security property. The lesser equity may make the borrower less inclined to appropriately protect and maintain the property.
What can the broker do? n Does the first mortgage prohibit further
mortgages? The broker should first determine whether the first mortgage contains the clause prohibiting further mortgages. Almost all mortgages do. If the first mortgage documentation does not contain such a clause, the broker acting for the borrower may proceed. n Obtaining informed instructions from client If the first mortgage does contain such a clause, the broker should obtain informed and written instructions from the borrower before proceeding. The instruction form should include that the client understands unless consent is obtained from the first mortgage lender to register the second mortgage, the registration could be a default under the first mortgage and entitle that lender to immediate payment of the full balance owing under the first mortgage. Failure to
