Second charge or second mortgages
Second charge mortgages are often referred to as second mortgages because they have secondary priority behind your main (or first charge) mortgage. They are a secured loan, which means they use the borrower’s home as security. Many people use them as a way to raise money instead of remortgaging, but there are some things you need to be aware of before you apply.
How does a second mortgage work?
You must be a homeowner to get a second mortgage, although you do not necessarily need to live in the property.
A second charge mortgage allows you to use any equity you have in your home as security against another loan. It means you will essentially have two mortgages on your home.
Equity is the percentage of your property owned outright by you, which is the value of the home minus any mortgage owed on it. For example, if your home is worth £250,000 and you have £150,000 left to pay on your mortgage, you have £100,000 equity.
A second charge mortgage can be a loan of anything from £1,000 upwards.
Lenders now have to comply with stricter UK and EU rules governing mortgage advice, affordable lending and dealing with payment difficulties. This means that lenders now have to make the same affordability checks and ‘stress test’ the borrower’s financial circumstances as an applicant for a main or first charge residential mortgage.
Borrowers will now have to provide evidence that they can afford to pay back this loan.
For more details on what an affordability assessment might involve, and the evidence you may be required to provide to support your second mortgage application, read How to apply for a mortgage.
Why use a second mortgage?
There are several reasons why a second charge mortgage may be useful.
- If your credit rating has worsened since taking out your first mortgage, remortgaging could mean you end up paying more interest on your entire mortgage, rather than just on the extra amount you want to borrow.
- If your mortgage has a high early repayment charge, it may be cheaper for you to take out a second charge mortgage rather than to remortgage.
- If you’re self-employed and are struggling to get some form of unsecured borrowing such as a personal loan.
When a second charge mortgage may be cheaper than remortgaging
John and Claire have a £200,000 five year fixed rate mortgage with three years to run until the fixed rate deal ends. The value of their home has risen since they took out the mortgage.
Their mortgage has an early redemption penalty of 5% of the mortgage’s value, so that’s £10,000.
They have decided to start a family and want to borrow £25,000 to refurbish their home. Should they remortgage or take out a second charge mortgage?
- If they remortgage, they’ll have to pay the £10,000 penalty and there’s no guarantee that they’ll be able to get a better interest rate than the one they are currently paying – in fact they may have to pay more.
- If they take out a second charge mortgage, they will pay a higher interest rate on the £25,000 than they pay on their first mortgage, plus fees for arranging the second charge mortgage. However, this will be far less than paying the £10,000 early repayment charge and possibly a higher interest rate on their first mortgage.
John and Claire decide to take out a secured loan that doesn’t have any early repayment penalties beyond three years (when their main mortgage deal ends). At this point they can decide whether to see if they can remortgage both loans to get a better deal overall.
When not to use a second mortgage
Did you know?
In 2014, 447 properties were repossessed by second charge lenders.
Source: Finance and Leasing Association
Although second mortgages can be useful, taking one out is a serious step. There are several situations where taking one out may be a bad idea.
- If you’re already only just managing to repay your mortgage. You could lose your home if you cannot keep up repayments on either your mortgage or the second charge mortgage.
- To consolidate debts. Using a second charge mortgage – which can run for up to 25 years – to pay off smaller debts, such as credit cards or small unsecured loans, will mean you may end up paying more interest in the long term. You are also converting unsecured credit into secured credit, which could increase the risks of having your property repossessed.
What if you move house?
If you sell your home you will either need to pay off your second charge mortgage or transfer it to a new mortgage.
Some things to consider before taking out a second mortgage
Before you take out a second charge mortgage, it’s a good idea to get advice from a suitably qualified individual. They will be able to help you find a loan that best meets your needs and financial situation.
They will have to follow the rules as set out by the FCA when dealing with you. These rules are designed to protect you.
If you choose not to get formal advice, you run the risk of taking a loan that isn’t suitable for you. If this happens, you may find it difficult to raise a successful complaint.
When you’re looking into a second charge mortgage, make sure you:
- Approach your existing lender and ask them what they would charge for an additional loan
- Shop around – make sure you get the best rate by comparing lenders’ APRC (annual percentage rate of charge), the duration of the loan and the total amount you’d have to pay back, and
- Find out the exact mortgage terms, fees, early repayment charges and rates of interest
Binding offer and reflection period
When the lender makes you an offer, they will have to give you an adequate explanation of the loan’s essential features. They will also have to give you a personalised document that:
- summarises these features including any fees, the APRC and changes to your monthly repayments if the interest rates rise beyond a particular point
- recaps some of the details of your loan application, and
- gives you the terms of their offer.
This document is known as an European Standardised Information Sheet (ESIS).
You’ve the right to take at least 7 days, from the time the offer is made, to think about whether you want to accept the lender’s offer. Some lenders may give you more than 7 days to think about their offer. This time is known as the ‘reflection period’.
During this time, the lender’s offer is binding and they will stand by the terms they’re offering you. They may change the terms of the offer in certain circumstances, such as the information that you gave in the application is found to be false.
It’s a good idea to take advantage of this time to not only think about the offer you’ve received, but to also compare it to other loans. Rushing to accept an offer could result in you in missing out on a more attractive loan elsewhere.
You don’t have to wait out the full reflection period to tell the lender you’ll accept the mortgage if you’re very sure that you want to go ahead with it.[
The risks and alternatives
As a second charge mortgage works very much like your first mortgage, your home is at risk if you don’t keep up the payments. If you sell your home, the first charge mortgage gets cleared in full before any money goes towards paying off the second charge, although the second charge lender can pursue you for the shortfall.
If you need to borrow a small amount of money you are better off going for an unsecured product such as a personal loan.
If you don’t have a large early repayment charge on your mortgage and you have some equity in your home and your circumstances haven’t changed, you’ll almost certainly be better off remortgaging or taking out a further advance from the same lender.