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