What Is Secondary Financing?

Secondary financing is a term used to describe any financing arrangement that is considered junior or secondary to any pre-existing financing arrangement. One of the more common uses of this type of financing is found in the arrangement of second mortgages that are sometimes taken out by homeowners as a means of funding repairs to the home or settling other debts. In the event that a debtor should default on his or her obligations, the secondary financing does not have primary claim on the assets pledged as collateral, and the debt must wait to be settled until the first or primary debt in the sequence is addressed.

In most ways, secondary financing works just like any other financing solution. Applicants submit applications to lenders, who then review the application details and investigate the financial background of the applicant. Typically, that applicant must meet the basic criteria established by the lender, especially in terms of credit rating, income levels, current debt load, and any other factors that the lender considers relevant to the ability of the applicant to repay the loan according to terms.

What sets secondary financing apart is that applicants must provide information on any primary financing that is already in place. For example, if a homeowner wishes to take out a second mortgage, he or she will include information about that first mortgage to a potential lender. That information will be verified and considered along with all the other data collected. If the current amount of equity in the home is sufficient, and the lender believes that the debtor is financially stable and capable of repaying the second mortgage according to terms, then there is a good chance the second mortgage loan will be approved.

The major risk for lenders who provide secondary financing is that some chain of events will render the debtor unable or unwilling to settle the debt according to those terms. For this reason, obtaining this type of financing can be more difficult than obtaining a first loan. When a previous obligation holds primary claim on an asset as part of a collateral or lien agreement, that debt must be considered first. In the interim, the lender holding that secondary financing is required to await the outcome. Even once the primary obligation is settled, the potential for the secondary lender to incur a loss is still very pronounced, since there may be very little left in the way of resources once that primary debt is settled.

Rates on secondary financing are often determined based on a number of factors. The average fixed lending rate in the area will be one consideration, along with the level of risk that the lender assumes in approving the loan application. Lenders also routinely limit the amount of the secondary financing based on a percentage of the current equity in the property or other asset. This helps to limit the risk to some degree, while still making it possible to enter into a financing arrangement that ultimately benefits both the lender and the debtor.