When Is a Second-Charge Mortgage the Better Option?

Alex Parsons Alex Parsons | Secured Loan Expert

Homeowners have multiple options when they need to raise tens of thousands of pounds in financing using the equity in their homes as collateral. For example, a homeowner can get a secured loan by way of a second-charge mortgage or opt to remortgage the home in anticipation of borrowing more than is necessary to pay off the original mortgage. One question we hear quite often is one of when the second-charge mortgage is the better option.

There are no hard and fast rules that explicitly state how the homeowner should use equity to obtain financing. There are some general guidelines, but the decision often rests in individual circumstances and goals. What might be appropriate for one homeowner could be a potential disaster for another.

Our best advice to you is to take some time to step back and evaluate your total financial situation in relation to how much you want to borrow against your home. Then compare the typical second-charge mortgage with the most popular remortgage offers out there. Run the numbers to figure out which one will be more cost-effective over the long term. Doing the work before you start looking may help you avoid a regrettable decision later.

Interest Rates and Early Payment Penalties

The Money Advice Service offers an excellent illustration for determining how to obtain the financing you need. Their example assumes a young couple with a £200,000 mortgage looking for £25,000 for home renovations. The fixed rate term on their mortgage ends in three years; they face a 5% penalty if they repay the mortgage early.

A decision to remortgage would saddle the couple with a £10,000 penalty for early repayment. The Money Advice service further explains that there are no guarantees the couple will get an interest rate comparable to what they are currently paying. In light of both, it is appropriate to look at a second-charge mortgage instead.

A second-charge mortgage is likely to come at a higher interest rate than they are now paying on their current mortgage. Though that can be a disadvantage, the upside is that they will know going into it how much they will pay in interest for the life of the loan. Furthermore, the difference in interest rates is not likely to be so high as to exceed the £10,000 penalty that would be incurred through remortgaging. Doing the maths for this couple indicates that a second-charge mortgage is the better option.

Things to Be Considered

When comparing the second-charge mortgage option against remortgaging, there are multiple things to be considered. Interest rates and early payment penalties are just the start. Homeowners should also consider:

  • the amount of equity available
  • average loan-to-value ratios
  • current mortgage balance
  • current and expected future income.

Both remortgaging and getting a second-charge mortgage must be investigated in light of the fact that the homeowner is using his/her property as collateral. A consumer whose budget is already at the limits might want to wait until his/her financial position improves before making a move. Others with sufficient income can look at the above factors when comparing the options.

Second-charge products tend to be the better option in most cases from a pure financing standpoint. Whereas remortgaging does very little to take advantage of equity, second-charge borrowing uses equity as a financing tool. Therefore, it is likely that the second-charge mortgage would be the better option in cases where a property owner has significant equity and the income to support borrowing.

Sources:

Money Advice Service ?? https://www.moneyadviceservice.org.uk/en/articles/second-charge-or-second-mortgages

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