Second charge borrowing has boomed in the past year so we go back to basics to explain what it is, who it can work for, as well as some of the benefit
Second charge borrowing has boomed in the past year so we go back to basics to explain what it is, who it can work for, as well as some of the benefits and disadvantages of the product.
Figures from the Finance & Leasing Association show the market has risen by around a quarter year-on-year. Mortgage broker John Charcol reports a 30% increase in second charge borrowing.
If you’re a homeowner looking to borrow more money, a second charge mortgage may be a suitable option. Our guide explains the key features.
What is a second charge mortgage?
A second charge mortgage allows you to borrow money, usually secured against your home, on top of your existing or ‘first charge’ mortgage.
While second charge mortgages are usually geared towards those wanting to borrow bigger amounts and who have sufficient equity to support the loan, some lenders offer an ‘unsecured’ version for smaller amounts.
For loans secured against your property, any default on your repayments could lead to your home being repossessed; the first charge mortgage lender would essentially have ‘first dibs’ on the property, while the second charge lender would be second in line.
In order to get a second charge mortgage, you usually need to obtain permission from the original lender.
Who are second charge mortgages aimed at?
As a very basic starting point, it’s for people who want to borrow more money. Ray Boulger, senior technical manager at broker, John Charcol, says second charge mortgages may not be the best option for the majority of people, but it can be good for a minority.
He explains: “If you need more money for any variety of reasons such as home improvement, to pay off debts or for school fees, having decided you want to borrow that money and that you can afford it, you need to look at what options are available to you.
“The next point is to consider whether you want to borrow on a secured or unsecured basis. If you only need a small amount, say up to £25k, there’s a chance an unsecured loan will be quicker and cheaper – starting at around 3% if you’ve a good credit rating. If you want to borrow more than £25k, that’s when you probably need to use your property for security.”
Homeowners then have one of three choices – 1) get an advance from an existing lender, 2) remortgage or 3) get a second charge mortgage.
Boulger says that while the first two are likely to be cheaper, second charge borrowing tends to be the last resort for those who are unable to remortgage or get an advance from their existing lender or where those options aren’t appropriate.
For example, you may have a very good deal with your existing lender so it doesn’t make sense to jump from the mortgage; you may already be in a fixed term deal, or have an interest-only mortgage.
Thousands of mortgage borrowers in the UK are on very low lifetime tracker mortgages taken out pre-2008, paying c. 2%. If you’re on one of these deals and you want to borrow, say £50,000 extra, your mortgage lender may insist you remortgage the whole deal onto a higher interest rate.
In this instance, it may well make sense to keep your existing borrowing at the lower rate guaranteed for the life of your mortgage, and just borrow the extra £50,000 as a second charge at a higher rate.
Over the past five years, the vast majority of mortgages taken out have been fixed rate deals which generally come with Early Repayment Charges (ERCs), which kick in if you leave your deal or remortgage before the end of your agreed term.
If you want to borrow the extra £50,000 and your lender is not prepared to lend it to you, leaving it early could cost you thousands which is why homeowners in this situation may want to consider second charge borrowing.
Boulger adds: “It’s also much more difficult to get an interest-only mortgage now so you may not be able to replace that deal. Even though a second charge mortgage is more expensive, it may be worth paying more to keep the cheap first charge. For example, if you have a £250k interest-only mortgage and you need £50k for an extension, you could be paying 0.75% on five-sixths of the mortgage while you pay a higher 5% on just one sixth of the mortgage bringing the average rate down.”
Another reason why you may want to consider second charge relates to timing. It can take a number of weeks to organise a remortgage. If you need extra finance and quickly, going for a second charge might be the quickest option available to you.
Lastly, Boulger says that people may use second charge mortgages when their personal circumstances have changed. An example might be on a joint mortgage where one partner has gone self-employed, potentially making remortgaging harder. In this case, a second charge may be more appropriate as long as you can prove you have an alternative and viable income stream to cover the payments.
What are second charge mortgages used for and what rates can you expect?
Data from John Charcol reveals that the majority of its second charge customers used the money towards consolidating debt, requirub an average amount of £90k. Nearly a third of its customers used the second charge mortgage for home improvements, averaging £96k and a fifth borrowed money to buy another property.
The table below details John Charcol’s second charge loan data:
Nearly all second charge mortgages are done through brokers and the fees for taking out the deals will be higher.
As detailed above, the rates are also higher: data from Moneyfacts reveals that the lowest second charge mortgage rate is offered from United Trust Bank – a lifetime tracker rate of 3.90% and it comes with a £495 product fee and £495 arrangement fee. The minimum term is three years, maximum of 30 and the minimum advance is £10k, up to a maximum of £125k.
The highest rate is offered from Shawbrook Bank – 20.40% on a maximum LTV of 95%. The minimum term is five years up to 25 years with the advance set between £3k and £30k. It comes with a £495 arrangement fee.
Boulger suggests homeowners taking out second charge mortgages do so for a longer period of time than needed, for example over three years rather than two, just in case at the end of the second year you aren’t in a position to pay off the amount.
Boulger says the market is becoming more prominent: “In March 2016 the second charge market became regulated by the Financial Conduct Authority. Having both the first and second charge market regulated should make it an easier process and there are now a few lenders who now offer both. We will see more lenders coming to the market, making it much easier for consumers and we’re also seeing a much better range of options. Until recently there wasn’t much choice in terms of interest rates, most were variable but we’re now seeing choice in the two, three and five-year fix range.”
The second charge market is estimated to stand at £1bn, though nearly 50% of the market is made up of the Help to Buy equity loan scheme, helping those with small deposits get on to the property ladder.