The words 'security' and 'safety' often go hand in hand. After all, security protects us from harm or loss. When it comes to home loans, lenders also seek security - typically in the form of the property itself, which serves as collateral for the loan.

So what exactly does 'security' mean in the context of home loans? And does the property you're buying always have to be the collateral? Let's break it down. 

What is security on a home loan?

When you take out a home loan, you'll need to offer an asset - usually the property itself - as security for the loan. That asset will act as collateral if you default on your mortgage, meaning your lender will be able to repossess your asset if you fail to meet your repayments.

Typically, the asset used as security on a home loan is the property being funded.

Thus, if you don't meet your repayment obligations, your lender might repossess your home, kick you out, and sell it on the market to recoup the debt.

See also: What does Mortgagee in Possession Sale mean?

While the idea of repossession isn't pleasant, home loan security benefits borrowers too. Mortgages are considered secured loans, meaning they usually offer:

  • Lower interest rates compared to unsecured loans.

  • Higher borrowing power, as the lender has a way to recover its money.

This is one reason home loans typically come with better terms than unsecured loans like personal loans or credit cards.

What types of security do mortgage lenders accept?

The most common asset used as security in a mortgage is by and far the property funded using the loan. However, there are other options.

Most common: The property itself

In most cases, borrowers use the property they're buying - or one they already own - as security for their home loan. This is the standard approach most mortgage lenders expect, and choosing an alternative security option typically requires additional approval.

In fact, the definition of the word 'mortgage' is a deal in which a lender takes on the title of the property until the borrower repays their debt.

Tip: As property titles are managed by state or territory governments, a person mortgaging a home will face a mortgage registration fee, charged by the relevant land and titles office.

Other security options

That said, it's possible to use other assets as security for a loan funding the purchase of a property - though technically, such a loan may not always be classified as a traditional mortgage.

Lenders may allow borrowers to use assets valued at more than the loan amount as security. This could include:

  • Shares

  • Term deposits

  • Business assets

  • High-value belongings, such as art or jewelry

Using another property as security

Borrowers can also use an existing property as security for a home loan. This means:

  • The loan is secured against an already-owned property rather than the one being purchased, as might be the case if you were to refinance to access equity for the purchase

  • This is similar to cross-collateralisation, where multiple properties are used to secure a single loan (more on this below)

Further security: Home loan guarantors

A guarantor is typically a parent or close family member who offers their own property as additional security for a borrower's home loan.

How does a guarantor help?

Once the borrower builds enough equity, they can refinance to remove the guarantor's liability.

Until that point, if the borrower defaults on their mortgage, the guarantor may be legally required to cover repayments. If neither the borrower nor the guarantor can meet the debt, the lender might sell the borrower's property first - and, if necessary, pursue the guarantor's property to recover the outstanding balance.

Lenders usually require guarantors to seek independent legal advice before signing the agreement.

Why a borrower's LVR matters

So, we've covered why lenders demand collateral on mortgages and what happens to said collateral if the borrower fails to make their repayments. It might now make sense why lenders care about a borrower's loan-to-value ratio (LVR).

As the name suggests, the LVR represents the difference between how much a person borrows and what the loan's security is worth. A higher LVR represents a larger risk for a lender, as it might not be able to recover the entire debt if it comes to repossession.

For that reason, lenders tend to take out LMI policies on home loans taken out by borrowers with LVRs of 80% or more. The LMI provider will then cover any losses borne by the lender if the borrower were to default - but it's the borrower who pays for the policy.

You might be able to dodge LMI by putting down a larger deposit, getting a guarantor, or using the Home Guarantee Scheme.

What happens when you sell the property?

Selling a mortgaged property is straightforward, but you'll need to discharge the mortgage - removing the lender's interest from the property title - for which you'll need to pay a fee.

This happens at settlement, and your conveyancer or solicitor will manage the process.

Steps when selling a mortgaged property:

  • The buyer pays the settlement amount

  • The lender takes its share to pay off the loan

  • Any remaining funds go to the seller

What if you sell the property for less than you owe?

If you sell the property for less than the outstanding balance on your home loan, however, the remaining debt doesn't just disappear - it still needs to be repaid.

You'll either need to repay this out of your own pocket or organise for it to be restructured, potentially with a new asset as security. 

Can you change or remove a security on a mortgage?

Yes, it is possible to change or remove a security on a mortgage, but it generally requires lender approval and may be subject to strict conditions.

You'll also likely need to pay a discharge fee and a mortgage registration fee.

Home loan portability

Perhaps an easier option would be to see if your home loan lender offers mortgage portability. Home loan portability - sometimes called security swap or substitution - lets you move your mortgage from one property to another.

This can be useful if you're moving home, particularly if you're doing so with a fixed interest rate as you won't face break fees.

Cross-collateralisation: Securing one mortgage with two properties

Finally, if you're investing in property, or considering doing so, you might have come across the term cross-collateralisation. It means to take out one mortgage secured against two properties.

Cross-collateratisation can allow a borrower to essentially put down a non-cash deposit. Let's use an example:

Paul owns a $600,000 home and wants to buy a $500,000 investment property. Instead of saving a $100,000 deposit, he uses his existing home as security, leaving him with:

  • $500,000 in debt secured against $1.1 million in property.

  • A 45% LVR

Photo by Obi - @pixel9propics on Unsplash

Collections: