Secured loans - Homing in on debt
We see them advertised on the television but do we really know
what they are? Laura Brady sorts fact from fiction when it comes to taking a
secured loan…
Not all money that is lent against your property is necessarily ‘a
mortgage’. In
some exceptional cases, where a mortgage is still in place but the road between
lender and borrower has come to an end, it is necessary to take a secured or ‘second
charge’ loan. This is a separate loan issued from a separate company but
still secured against your home.
Looking at your lender
For a number of reasons, a second
charge loan should be a last resort for homeowners. In fact, only 10 to 15
per cent of borrowers who have taken one needed to, estimates Ray Boulger,
senior technical director at broker John Charcol.
The first option should always be to look at your existing mortgage, says
Boulger. This could mean either
remortgaging and releasing more funds against the value of your property, or
taking a further advance where you
retain your mortgage but borrow additional funds from the lender as a separate
‘top up’ loan.
A remortgage will mean the entire
loan is borrowed at new rates, which could even be more competitive. If you take
a further advance, it is likely that the balance of the extra funds will be
charged at the lender’s standard variable rate (SVR), regardless of what you are
paying on your primary loan. “And be careful that the further advance does not
come with tie-ins that extend beyond those that may apply to your mortgage,”
says Boulger.
But circumstances change over the years. It could be that you have run into bad
credit or that your salary has gone down and the income multiples required to
borrow more against the house do not stack up. Depending on what you want the
money for, your lender may also refuse to release funds that take your mortgage
beyond 95 per cent Loan to Value (LTV) – especially if you have only had the
original loan for a short time. All or any one of these reasons could mean you
are unable to qualify for either a remortgage or a further advance with your
current mortgage lender.
The next step…
In this case, unsecured borrowing should be your next step. You can take out a
personal loan of up to £25,000 for an interest rate as low as 5.5 per cent.
However, the maximum term for this kind of loan is usually five years. By
contrast, a second charge loan will allow you to spread the repayments over 25
years (providing this doesn’t take you beyond retirement age) translating into a
lower monthly cost.
But if you can afford a shorter-term loan, are seeking to borrow £25,000 or
less, and are eligible for unsecured borrowing, there is “no economic logic” to
taking a second charge loan, says Boulger.
When is a second charge loan necessary?
But, according to Josh Cooper, spokesperson for loan and
mortgage broker,
Freedom Finance, there are situations where a second charge loan can “make an
awful lot of sense”. He says: “It could be that you are able to remortgage but –
because you have had some recent arrears – you would have to transfer the whole
mortgage to expensive sub-prime interest rates. In this case you might be better
off retaining the current low mortgage rates for the bulk of the loan and taking
a smaller one– albeit more expensive – from a separate secured lender.”
Similarly, if you want to take a loan over a short period of time but don’t
qualify for unsecured borrowing, the costs of remortgaging or taking a further
advance may not be justified. “Higher lending charges, arrangement fees and
legal and valuation costs can make sense when taking a loan for 25 years – but
perhaps not for five,” says Cooper.
Another situation where a homeowner could benefit from a
secured loan is if
they need to raise money quickly. A secured loan can be turned around in just 48
hours from the point of application, says Cooper. Also, if you are tied into a
fixed or discount deal that requires you pay a hefty redemption penalty to
leave, a second charge loan could be a more cost-effective means of borrowing.
The costs of a second charge loan
If you have exhausted all the alternative options and are convinced that a
second charge loan is right for you, brace yourself for the cost. If the loan is
small in proportion to the equity in your house and you have a decent credit
rating, rates will still start at around 7.9 per cent – 3.5 per cent higher than
on a competitive mortgage deal. From there rates can go up to and beyond 20 per
cent, which is equivalent to typical credit card.
There are generally no upfront fees to pay when taking a secured loan, but of
course this ‘discount’ will be factored into the interest rate. The good news is
that the controversial Rule of 78 was scrapped last year. This means you can now
redeem a second charge loan early should you come into money, typically paying
just two months’ interest in early repayment charges, as well as interest to the
end of the month.
How much can I borrow?
Secured loans are
calculated on a combined loan to value basis. By the very nature of a secured
loan, the LTV cannot go above 100 per cent of the property value at the time of
borrowing. So if you have an 80 per cent LTV with your current mortgage lender,
a second charge loan would only lend a maximum of 20 per cent. In the event that
you default on your mortgage, your mortgage lender will repossess its full share
(80 per cent in this scenario) first. The second charge lender will follow
behind to claim what’s owed, which means it will suffer the shortfall if your
property has depreciated in value. This is why the loan is called ‘second
charge’ and – as the lender is more exposed – it’s also why the rates are so
expensive.
Where can I get a
secured loan?
Secured loan companies often advertise on the television or in the tabloid
press but contacting one of these companies direct is not always a good idea.
This is because secured loans represent one sector of the consumer finance
market that is not yet covered with a blanket regulation. Although the
Department of Trade and Industry (DTI) loosely regulates some secured lending
this only applies to loans of £25,000 or less. “That’s why many companies will
advertise minimum loans for £25,001 so it is taken out of the regulatory field,”
says Boulger. However a EU consumer credit directive is currently under
discussion, which will scrap this limit and bring second charge lending of any
amount under regulation.
When looking for a second charge loan it’s a better idea to make a recognised
broker your first port of call. “Especially as the first thing we do on
application is a Fact Find,” says Cooper. “This means we assess whether a
remortgage, secured or unsecured lending is most appropriate for your
circumstances. This is certainly not the case with all second charge loan
brokers.”
This process – and the whole application – can be carried out on the telephone
and borrowers can usually get an instant decision. However, bear in mind that
although the lender will not levy upfront charges, a broker fee will be payable
on completion, which will depend on the amount borrowed. With some loans, you’ll
not be charged a penny, but some charges can go as high as 10 per cent of the
amount you want.
Watch out…
Another hurdle to look out for when taking a secured loan is
Payment Protection
Insurance (PPI), which can represent exceptionally poor value, warns Boulger.
“Because of the lack of regulation, it is sometimes implied to the customer –
who, of course, is on a down-foot anyway – that they will only be accepted for
the loan if they take the PPI. But PPI has nothing to do with it,” he says.
The insurance, which is added to the cost of your monthly repayments, is
notoriously expensive and often does not pay out when a borrower claims. In fact
PPI is such a grey area, the Financial Service Authority (FSA) is currently
reviewing how providers should ensure their customers are more fairly treated,
says Boulger.
A short-term solution
Second charge loans are generally not good news and taking one should be a last
resort for any homeowner. With this in mind it is still imperative to seek
independent financial advice before making any decisions. If the lights are
still green, when choosing a loan, prioritise features such as overpayment
facilities and flexibility. This will smooth the way to getting rid of it as
soon as possible – something that should be your next priority.
This article has appeared in Mortgage Magazine which is available in all good newsagents. Copyright MSM International Ltd
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