How do secured loans work?
A secured loan is similar to an unsecured personal loan in that it allows you to borrow a certain amount of money over a set term. You then repay your lender in monthly instalments, which are usually fixed at the same level for the duration of the loan.
However, a secured loan differs from its unsecured cousin because the amount you borrow is secured against an asset – usually your home. In this context, secured means the lender can take position of the asset if you default on the loan.
Because of this, secured loans are sometimes referred to as homeowner loans or second charge mortgages. It’s called a ‘second charge’ because the original mortgage will always take priority if your property is sold to pay your debts.
Secured loans are riskier than unsecured loans because, if you are unable to keep up with your repayments, you could lose your home.
But on the flipside, the loans represent less of a risk to the lender because of the secured asset, and this means the rate of interest charged is usually lower than with the unsecured variant.
What do secured loans offer?
Borrowing limits for secured loans are generally higher than they are for unsecured loans, which means secured loans can be suitable for those looking to borrow funds of £25,000 or more.
For this reason, they can be useful if you need to fund significant home improvements such as an extension, or if you want to consolidate a raft of existing debts.
Loan terms are also typically much longer than for unsecured loans, where the maximum with most lenders is five or perhaps seven years. You can usually borrow on an unsecured loan for a period of between three and 25 years, although longer deals are available.
How much you can borrow and the length of the term you will be offered will depend on your credit rating as well as how much equity you have in your home.
If you have little or no equity in your home – that is, its value is close to your outstanding mortgage – then your chance of getting an unsecured loan is limited, if non-existent. That’s because the mortgage lender will always have first call on your property.
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What are the advantages?
One of the main advantages of a secured loan is that you can usually borrow a larger amount than you can through other types of credit.
A secured loan may also appeal because it typically has a much longer repayment period, which means monthly repayments will be lower.
What’s more, as noted above, because your loan is secured against your home, lenders regard this type of loan as less risky, so interest rates are often lower compared to unsecured loans.
You’re also less likely to be turned away if you have a poor credit score, although be aware you may pay a higher rate of interest if this is the case.
What are the disadvantages?
Although secured loans have many advantages, there are also several drawbacks to be aware of. These include the following:
Your home is at risk
Because your loan is secured against your home, if you are unable to keep up with the repayments, your lender has the legal right to repossess your property. This means you could be forced to sell your home so that the lender can recoup their money.
If at any point you become concerned you won’t be able to keep up with your repayments, talk to your lender as soon as possible. Your lender may be able to come to an arrangement with you to help pay off your debt without losing your home.
You may not get the interest rate advertised
Although you can still qualify for a secured loan with a poor credit score, be aware your interest rate is likely to be higher than for those with good credit scores.
Lenders must offer the advertised annual percentage rate (APR) to at least 51% of borrowers, but this also means 49% of customers could be offered a higher rate.
Interest rates can be variable
Be sure to check whether the loan you’ve chosen has a fixed or variable rate of interest. Many secured loans have variable rates which means your monthly repayments could increase at any time.
The equity in your home affects how much you borrow
When you apply for a secured loan, the lender will look at how much equity you have in your property to decide how much to let you borrow. If the amount of equity in your home is low, the amount you will be able to borrow will be limited.
Longer repayment terms mean you’ll pay more
Being able to repay your loan over a long period of time means your monthly repayments will be lower, but keep in mind that the longer the term of the loan, the more you will pay in interest over the life of the deal.
Early repayment charges may apply
Should you wish to repay your secured loan early, you may have to pay an early repayment charge. This could be the equivalent of one to two months’ interest.
There may be an arrangement fee
When comparing loans, keep an eye out for other fees such as arrangement fees or broker fees. These are not usually charged on unsecured loans.
What else should you consider before applying?
Before applying for a secured loan, it is a good idea to check your credit rating through a fee-free service such as Experian or Clearscore.
Although your credit score doesn’t have to be perfect to be accepted for a secured loan, the lower your score, the more interest you are likely to pay.
If your credit rating isn’t as good as it could be, there are steps to take to improve it such as checking you’re registered on the electoral roll, correcting any errors on your report, spacing out credit applications by at least three months, and paying bills on time.
When comparing secured loans, it is important to consider how much you can realistically afford to borrow. It’s vital not to overstretch yourself – remember if you can’t afford your monthly repayments, you risk losing your home.
Also consider the length of the loan. Choosing a shorter term will increase your monthly repayments, but it will also help you pay back the debt faster, saving interest.
Why opt for a secured loan/second charge mortgage?
A secured loan is often used as an alternative to remortgaging, and the equity in your home is used as security against an additional, separate mortgage – so you will have two mortgages on the same property.
Before applying for a second mortgage, it’s worth asking your existing lender what it would charge for an additional loan and comparing this to what else is on the market.
Don’t forget to factor in any fees when comparing deals.
Who might benefit?
A second charge mortgage can be worth considering if you are self-employed or your credit score has deteriorated and you are finding it difficult to get accepted for other forms of credit.
Even if you are accepted for other credit types, a poor credit score often means you will pay a higher rate of interest. With a second charge mortgage, however, you only pay extra interest on the additional amount you borrow above your existing mortgage, which can make it a cheaper option than remortgaging.
It can also be cheaper than remortgaging if you have to pay a high early repayment charge to get out of your existing mortgage early – this can be the case even once you’ve factored in a potentially higher interest rate on the second mortgage and arrangement fees.
Lenders will want to see evidence that you can afford your monthly repayments when you apply. If you are already struggling to keep up with the repayments on your existing mortgage, it’s best not to apply for a second mortgage.
Keep in mind, too, that as second mortgages can last as long as 25 years, choosing one to consolidate smaller debts could result in you paying more interest in the long-term, even if the monthly payments are lower.
If you are considering applying for a second charge mortgage, it can be a good idea to speak to a mortgage broker first.
What are the alternatives?
If you are not sure whether a secured loan/second-charge mortgage is right for you, there are a number of alternatives to consider. These include:
It can be cheaper to remortgage than take out a second mortgage if you don’t have a high early repayment charge to pay or if you can wait until your existing mortgage deal ends.
Unsecured personal loan
Personal loans allow you to borrow between £1,000 and £15,000, with some lenders offering larger loan amounts of up to £25,000. The main advantage is that your loan won’t be secured against your home. You can usually repay your loan over a period of up to five years, although this can be longer.
0% purchase credit card
This type of credit card allows you to spread the cost of your spending interest-free over several months. It can be a good option if you have a one-off purchase to make, such as a new car, but be aware the amount you can borrow will usually be much lower than with a loan. Plus, once the 0% deal ends, interest will kick in.
0% money transfer credit card
With a money transfer card, you can shift funds from your credit card straight into your bank account and then use these funds to pay off existing debts or to put towards purchases. Be aware there is usually a transfer fee to pay and once the 0% deal ends, you’ll pay interest.
0% balance transfer credit card
A 0% balance transfer card can help you to consolidate existing card debts more cheaply as you won’t have to pay interest for several months. Just watch out for the transfer fee and make sure you clear your balance before the interest-free deal ends.
If you use a credit card, you’ll also get protection under Section 75 of the Consumer Credit Act if your supplier fails to deliver the promised goods or services.