When To Consider A Second Charge Mortgage
There are a number of situations where a second mortgage should be considered.
Before being regulated by the Financial Conduct Authority around 8 years ago, the second charge market was sometimes recognised as a product of last resort. Early redemption penalties were often excessive and various clauses meant that if you missed a repayment the interest rate on your loan would unfairly increase.
However, with the regulatory changes, a second mortgage is now seen as a mainstream product and is taken into account when a mortgage broker gives advice.
While these mortgages are generally used as debt consolidation loans or to carry out home improvements, you are able to borrow for most legal purposes.
Stay With Your Mortgage Company
There is currently a trend for people to take out a fixed rate mortgage agreement when they buy a property. The mortgages are typically fixed for the first 2 years, 3 years, 5 years, or 10 years giving borrowers the comfort that their mortgage repayments will be fixed at the same repayment for that initial period. This makes it easy to budget.
The only potential issue is that if you want to borrow a further amount during the fixed period, perhaps to improve your home, you may have to consider remortgaging to another lender if your current lender is not prepared to lend you the additional amount you require. Normally in this scenario, your current mortgage lender would charge you an early redemption charge (ERC) for paying off their mortgage during the fixed rate period.
This becomes more relevant the larger your mortgage is. Some lenders charge a 4% early repayment charge if you repay their mortgage in the first year. If you took a mortgage of £250,000 this would equate to an early redemption penalty of £10,000.
If you keep with your current mortgage lender and take out a secured loan you would avoid having to pay an early repayment charge to your first mortgage company. Then at the end of the fixed rate period when there are no penalties you could look to remortgage and pay off the second mortgage.
Your mortgage broker will look to see if a second charge mortgage is your best option as it might be that if you are borrowing a high amount against the value of your property, then you might have to pay a higher interest rate.
Your broker will consider the setting up costs on the second charge together with the interest rate and any early redemption charges that might apply.
You Have Recently Got Bad Credit
Through no fault of your own, you may have fallen into financial difficulty say 8 months ago resulting in you missing repayments on your financial commitments which will ultimately having an adverse effect on your credit rating. The problem was short term and you’ve brought the personal loan and credit card accounts up to date and made the last 5 repayments on time on all commitments.
If you wanted to borrow to perhaps extend your property you would normally approach your existing mortgage company. However, it is unlikely that they will agree to lend further monies as they will have seen through a credit search that you were struggling to meet your current commitments and it would be irresponsible for them to lend your further funds at the current time.
They may say that they would be happy to consider a further advance in 12 months once you have demonstrated for that period that you can maintain your current payments on your credit cards and loan.
This is another scenario where you should consider a second charge, particularly if the improvements are essential such as a new roof to replace a leaking one. You could subject to criteria, take out a second mortgage to get the works done, then in 12 months you could get the further advance from your current lender and repay the second mortgage.
If the home improvements are not essential, it might be better to wait 12 months and get a further advance from your mortgage company as the interest rate from them is likely to be considerably less than that of a second mortgage lender.
Alternatively, if you save money you might want to use a lump sum you have in a savings account.
Can I Get A Remortgage With Bad Credit
One consideration to raise funds for home improvements would be to look at a remortgage. With a remortgage you switch lenders, and the new lender pays off your current lender and lends you the additional amount you want.
For example, if you already have a mortgage of £200,000 and require a further £50,000, you would find a new lender who was happy to lend you £250,000 who would pay off your current mortgage lender and you would receive £50,000 to carry out your home improvements.
While you might be keen to carry out home improvements by remortgaging, you need to consider what interest rate you are going to be charged. Any lender will take into account your credit history and if you have missed some payments on your loans and credit cards it is likely you will be charged a higher mortgage rate because you are considered more of a risk.
Depending on your credit score, the interest rate might be 3% higher than someone who has good credit. On an interest only mortgage of £250,000 this would equate to you paying an extra £625 per month.
Again, if the improvements are not essential it might be better to wait until your credit score has increased at which point you should be able to benefit from more competitive interest rates from a choice of lenders.
If the improvements are essential and you can demonstrate that any problems that resulted in the missed repayments are resolved, subject to a credit search, your income, and the available equity in your property, you could explore a second mortgage. Once the improvements have been carried and your credit score has improved you could look at remortgaging and paying off the second charge lenders.
A mortgage broker will consider a second charge mortgage when an applicant's income is failing what is called a loan to income ratio (LTI). Generally, first mortgage companies are restricted to lending 4.5 times a person's income.
Therefore, someone earning £50,000 would be restricted to total mortgage borrowing of £225,000, meaning that someone who had a mortgage of £200,000 could only potentially raise a remortgage of £225,000.
There is generally more flexibility with second charge lenders in that they often lend up to 6 times someone's income. In this example, someone could keep their existing mortgage of £200,000 and raise a further £100,000 by way of a second charge.
In addition to a lenders loan to income calculation, they carry out an affordability assessment to ensure someone can afford the proposed repayments. The net income is calculated and then the monthly outgoings are deducted to ensure that there is a surplus sufficient for the applicants to comfortably afford the repayments. Some lenders will use figures produced by the Office for National Statistics (ONS) to ensure that the figures are realistic.
Ultimately, any lender needs to be comfortable that any borrower will be able to afford the monthly repayment not only now, but for the duration of the loan term.
It would be advisable to speak to a qualified mortgage broker who is regulated by the Financial Conduct Authority who can explore the various mortgage deals on offer. Ensure that your broker is CeMAP qualified (Certificate in Mortgage Advice and Practice). Make sure you are clear of any fees the broker is charging.