Second charge mortgages rise: How risky are they?

As mortgage rates have risen, borrowers understandably want to hold on to their lower fixed rates for as long as possible and avoid taking out more expensive mortgages unless absolutely necessary.

This poses a potential problem for those looking to take out a new mortgage in order to use some of their home’s equity in cash, for example if they want to renovate or consolidate debt.

As a result, lenders and brokers are reporting an increase in the number of customers considering second charge mortgages – a second, separate loan secured against a property’s equity.

For example, the interest rate on the primary mortgage remains the same, which can save a considerable amount in view of the recent rate increases.

Accessing cash in this way has numerous drawbacks. Rates are higher than standard mortgages, and if you can’t make the repayments, you could end up losing your home. However, some say it makes sense in the right circumstances.

Borrowers took out £1.71 billion in second term loans in 2022, a 45 per cent increase from 2021, according to second mortgage specialist LoanWarehouse.

Second charge loans are especially popular with those doing extensions and other major works on their home – and that’s on the rise.

Data from mortgage lender Together shows that one in ten (9 percent) homeowners plan to invest their finances in renovating their home rather than moving.

Within this group, 57 percent are aware of second charge loans, but the majority (60 percent) plan to use savings to cover the cost of renovations, while 8 percent plan to take out an unsecured loan and 5 percent choose to take out a new mortgage. to pay the costs.

Menachem Salzer, an accountant living in Salford, took out a second mortgage with Together in November 2022 – borrowing £68,950 – to fund a renovation and extension project to his family home.

Now that the renovation has been completed, two bedrooms and a bathroom have been added to the house, increasing its original value of £380,000 by approximately £70,000.

He had initially wanted to remortgage his primary loan, but since it’s a flat rate of 1.5 percent, he didn’t want to risk the increase.

“My real estate agent came up with the idea of ​​taking an additional charge on the property and leaving the existing mortgage as it is,” he told This is Money.

“We were desperate to do the extension because we needed the guest rooms, but because the [personal] loan had not been guaranteed, the interest would have been much higher. This was the cheapest option.’

‘The principal mortgage was probably in the region of £190,000 and additional loans were £70,000. So yes, I pay a higher interest on the addition, but I still pay a lower fixed interest on the main mortgage, so that works out cheaper.’

Is a second mortgage a good way to access extra money?

In certain circumstances, when you have a low fixed rate mortgage and want to take out a new mortgage to access more capital through the equity in your home, a second mortgage can be one way to do this.

There may be a time-sensitive situation where a standard remortgage or further advance will take too long, a criterion situation where a borrower is currently not suitable for a standard mortgage, or any number of other variables that make a secured loan. the only option,” said Gary Bush, financial advisor at Mortgageshop.com.

The affordability calculation that lenders make for a second mortgage is often more relaxed than the primary loan allows for a larger borrowing space, says Justin Moy of EHF Hypotheken.

Others suggest that this could be a way to consolidate multiple debts, especially since lenders often take a slightly more relaxed view of credit history than they do with other types of loans.

What are the disadvantages of an extra loan on your home?

Second charge mortgages are generally considered riskier by lenders, so attract higher interest rates. Currently, Moy says, rates start from about 6 percent, but they could go much higher.

For regular mortgages, the average two-year fixed rate is currently 5.34 percent and the average five-year fixed deal is 5.07 percent, according to Moneyfacts.

For second-term mortgages, Together currently offers 8.65 percent for a five-year fixed term and 8.95 percent for a two-year term.

On top of your existing mortgage, the compound interest of both loans quickly adds up.

The length of a second mortgage can also mean that compared to other loans, such as a personal loan, you end up paying interest longer, meaning you pay more overall.

It’s also worth noting that a second mortgage depends on the equity in your home. So even though it’s secured, meaning lenders are more likely to loosen their credit criteria and let people with weaker credit histories borrow, you’re losing equity in your home.

And if you can’t make your payments, you’re putting your home at risk, increasing your debt and reducing equity in your home.

Taking out a second mortgage can also limit your options if your circumstances change.

If you want to remortgage your first loan, move house, or take out an equity release product, a second write-off on your property may limit your ability to do so.

“You may have to pay the second charge before you sell or get permission from the lender to transfer the second charge to new premises, but they may not be willing to do that,” says Andrew Johnson, senior consulting manager at the Money and Pension Service.

Johnson adds that those receiving any form of government benefit, particularly those who are means-tested, should also think carefully about taking out such a loan as it could affect their eligibility.

“As a rule of thumb, if you can avoid getting a second charge on your property given the high interest rates, it’s probably better to look at other options first,” he says.