Secured loans & second charges advice
What is a secured loan?
A secured loan is a second mortgage for a property with an existing mortgage secured against it.
Any mortgage is (technically) secured against the property, so any loan using a property as collateral is a 'secured loan'.
But, it's conventional in the mortgage industry to refer to the first loan or 'charge' over the property as a mortgage, and a 'secured loan' is a term used to describe any subsequent charge made after the first.
The main difference between a mortgage and a secured loan is that the 'first charge lender', i.e., the original mortgage lender, is first in line (to the proceeds of the sale) if repossessed.
That makes offering secured loans a higher risk than mortgages, so the rates are generally higher.
What are secured loans used for?
Secured loans are for borrowing additional funds against a property (that you own) with an existing mortgage.
There is a broad range of acceptable uses for the money raised.
Most lenders can accept capital raising for home improvements, buying another property, as a deposit for a purchase, for personal use such as buying a car, a wedding, or even going on a holiday; debt consolidation, gifting to family members or various other scenarios.
Raising money for business purposes, such as paying a tax bill or using the funds to purchase a going concern, is possible, although fewer lenders would entertain this purpose.
When is a secured loan appropriate?
A secured loan is appropriate when you wish to raise additional funds from your property's equity and have an existing mortgage.
If an existing mortgage has early repayment charges that continue for some time, it's vital to consider whether a full remortgage could present a better option.
Where the existing mortgage has favourable terms, like a rate significantly lower than current deals, a remortgage may be much more expensive than a secured loan.
Secured loans typically have a higher rate than a mortgage, but as they are usually for much smaller sums, establishing the best cost option is vital as part of good advice.
Secured loans often have less restrictive requirements around credit history and affordability, so they may also be appropriate where the sums required are unavailable through a mainstream remortgage.
When is a secured loan inappropriate?
It follows that any property without an existing mortgage can usually achieve better lending terms through a traditional mortgage than a secured loan, and most secured loan lenders would refuse to lend on a first-charge basis.
Also, any first-charge lender has a legal right to veto the levy of a second-charge against the property. Many lenders (especially buy-to-let lenders) do not permit any second charge.
That is because the second charge lender could force a repossession, costing them money they may otherwise never have lost. The additional lending, therefore, raises the risk for both lenders.
So, if an existing lender does not consent to a secured loan, it is not appropriate to consider them.
There are some lenders who can still accept this situation, though, by using an 'equitable charge' that does not require the first-charge lenders' consent. As 'equitable charges' pose higher risks for the lender, these products are usually more expensive.
Where the borrowing amount is very low, the fees and costs involved in a secured loan are unlikely to present good value versus a personal loan or other revolving credit.
What alternatives are there to secured loans?
A full remortgage borrowing additional funds is an alternative that must be considered (in the advice process).
Also, borrowers may be able to take a 'further advance', i.e., additional borrowing on top of their existing loan with the current lender.
Although less common today, post credit crunch, many borrowers on trackers could borrow extra funds at the same rate as their existing deals, which were often very competitive.
Good mortgage advice has to consider all these options fully to ensure you receive good value.
Also, personal loans may be an option to consider, particularly when capital raising for debt consolidation or home improvements and the existing mortgage is due for renewal shortly, as avoiding early repayment penalties in the short term and subsequently refinancing into the primary mortgage may present better long-term costs.
Best advice will also consider whether there is any alternative property and the scope for other arrangements on these.
How do secured loans work?
As it is a second mortgage, processes will be nearly identical to buying a property or remortgaging.
It involves an application, providing proof of identity and financial commitments, usually including evidence of income and affordability. Credit checked, and the property valued (although often a 'desktop' digital valuation).
A similar range of products to traditional mortgages is available, with fixed rates, trackers and variables available. You can also vary the term to control the monthly payments. The products often have early repayment penalties, similar to first-charge mortgage deals.
Arrangement fees are considerably higher than a typical mortgage to account for the smaller borrowing amounts. The applicant usually pays for the valuation, now uncommon with first-charge loans.
There is a similar legal process to that in a remortgage. The legal work is often included free of charge.
As the borrowing is a 'second charge', it creates a further legal barrier; any future remortgage requires the 'postponement' of the second charge (the secured loan lender must allow the new lender to be first in line in a repossession).
That means there will usually be some additional legal fees to pay during any change of lender to the first mortgage (even when it includes a 'free legal' package), and any new lender must also accept a second charge being in place.
What are the pitfalls and risks of secured loans?
Secured loans have higher interest rates than traditional mortgages and usually have considerably higher arrangement fees.
As they have early repayment charges, they may often be inferior to a personal loan for relatively modest sums of lending, especially where the need is short term and likely to be consolidated again in the near term.
But their eligibility rules may also be less restrictive, so in any case, where intended for short-term purposes, there is a risk that consolidating a loan into the mortgage at a later date may become challenging if the market changes in the interim (like the recent hikes in interest rates).
So, the loan must be affordable long-term, regardless of whether intended as a short-term solution.
For further advice on secured loans, get in touch on 0345 4594490.