Brokering A Second Mortgage

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

Interest 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:

• 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.

• 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.

• may simply have come to desire other uses for the funds (such as holidays, vacations,

other investments, or meeting other obligations) and the default gives the lender the option of having the mortgage funds available early.

• 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.

• 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?

• 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.

• 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

1

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.

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make that payment could trigger foreclosure proceedings. If the client, after being informed of the possible consequences, instructs the broker to not proceed, that should end the matter.

• Obtaining consent from the first mortgage lender If the client, after being informed of the possible consequences, instructs the broker to proceed without obtaining consent from the first mortgage lender, the mortgage broker should obtain instructions to that effect in writing. The instructions should include that the borrower understands the advice the broker has provided and should be signed.

This protection for the broker could be very important if the first mortgage lender later calls its mortgage due and the client denies having provided the instructions or not having been informed before providing them. Do note that even with the borrower client’s informed instructions there is always some risk to the broker that a regulator or court could determine that the broker was not entitled to facilitate the breach of the first mortgage.

If the client, after being informed of the possible consequences, instructs the broker to proceed only with the consent of the first mortgage lender, the mortgage broker should obtain informed and signed instructions to that effect. This is important because once the first mortgage lender learns that the borrower is looking for additional funds and in effect cannot obtain those funds without his or her consent, the first mortgage lender is in a powerful position to decline consent and itself lend further funds for the borrower on terms favourable to the first mortgage lender. This could of course also have the effect of depriving the broker of an otherwise earned commission. The broker may want to instead have an appropriate commitment letter signed, providing that the commitment is subject only to the condition that the conveyancing lawyer obtain the consent of the first mortgage lender prior to the registration of the second mortgage.

If consent is requested and declined by the first mortgage lender, the broker should not encourage the borrower to proceed. As well, the broker should not lawyer-shop until one agrees to register the second mortgage, either not knowing of or not caring as to the first mortgage having withheld consent. This is discussed in more detail in the sidebar Illustrative Regulatory Case alongside.

• Closing the second mortgage transaction If consent is requested and approved by the first mortgage lender, the deal can proceed to closing with the borrower and the broker better protected.

• What shouldn’t a broker do? A mortgage broker who fails to obtain the informed instructions of the borrower or encourages a borrower to proceed in the face of the first mortgage lender declining consent risks regulatory action and civil consequences.

• Civil liability A broker being liable to a borrower for not having advised as to the possibility of the first mortgage lender calling its mortgage due would most likely be on the basis that either the broker:

• breached contract obligations (if there is such a contractual term in place); or

• was negligent (that is, not performing mortgage brokering services to the standard of a reasonably prudent broker).

It is far less certain that the broker would have liability for the non-client second mortgage lender or the first mortgage lender. That said, the categories of liability are never closed.

TAKEAWAY Not obtaining the consent of the first mortgage lender to register a second mortgage can expose the borrower to the first mortgage becoming due and the broker to regulatory action and civil liability. A prudent broker can take steps to minimize the exposure for both borrower client and the broker.

ILLUSTRATIVE REGULATORY CASE

In November 2008, the BC Registrar of Mortgage Brokers made an urgent suspension order against a broker for having conducted business in breach of the Mortgage Brokers Act and in a manner prejudicial to the public interest. 2 The broker had encouraged and facilitated the borrowers to proceed with obtaining a second mortgage, in the face of clear opposition from the first mortgage holder. The Registrar concluded that the broker’s conduct was to the prejudice of the first mortgage lender, second mortgage lender, borrowers and public interest.

The urgent suspension order was made also on the basis of the Registrar forming the opinion that the broker had:

• not provided required cost of consumer credit disclosure, conflict of interest disclosure, and lender information to the second mortgage lender;

• administered mortgages without the required administration agreement in place;

• not kept required accounting records; and

• taken no steps to ensure the developers were using the mortgage funds as intended.

The borrowers’ initial lawyer had refused to process the second mortgage because the first mortgage lender declined to consent to its registration. The broker, knowing this information, advised the borrowers that the first mortgage lender’s refusal was not a problem, as he knew another lawyer who could process the transaction for them. He advised them to proceed.

Indeed, the broker found another lawyer to process the second mortgage. The broker advised the borrowers that proceeding with the second mortgage would not put their home at risk provided the mortgage payments remained current. The broker told the Registrar’s staff that he advised borrowers “all the time” to proceed over the objections of a first mortgage lender, and this was the first time it had “backfired” on him. The broker was unaware of any requirement that would compel him to tell the borrower’s lawyer, or any other party to the transaction, of the first mortgage lender’s refusal.

The borrowers later went into bankruptcy. The first mortgage lender learned of the second mortgage in that process and commenced foreclosure proceedings based on the mortgage having been breached by:

• the claim of bankruptcy; and

• the registration of the second mortgage over its objections.

2

In the Matter of the Mortgage Brokers Act and Richard Dowding and RBD Financial Inc. dba Mortgage Connection (BC Registrar of Mortgage Brokers) Nov 13, 2008

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