Second charge mortgages: pros and cons

Monopoly housesA second mortgage might seem like a good idea, but you should make sure you understand the risks first.

The number of second charge mortgages being taken out this year is up 7% on the same period last year. This is the first increase in this type of lending for two years.
Second charge mortgages, also known as second mortgages or homeowner loans, are secured loans borrowed against your home. However, you don't necessarily need to live in the home to get one. They are called second charge because they have second priority behind your (first charge) original mortgage.

How second charge mortgages work
You use the equity in the home to fund a second charge mortgage. For example, if you have a home worth £200,000 and you have a mortgage of £125,000, you have £75,000-worth of equity.

If you want to borrow a lot of money – say £50,000 – you could remortgage. But if your credit score has decreased since you took out your mortgage - for example because you missed some repayments on a credit card - you might struggle to get a mortgage interest rate close to what you had before.

Or, in even more extreme circumstances, your credit history might be so bad that you can't remortgage at all.

In those circumstances, you could turn to a second charge mortgage.

Second charge mortgages are good for lenders as they have your home as collateral if you can't keep up with repayments. However, in the noughties, some lenders were even more lax with second charge lending than they were with mortgages, offering to lend money without thorough credit or affordability checks.

It's worth saying at the outset that if you're struggling with debt already, taking on more is not a good option.

Now let's have a more detailed look at the pros and cons of a second charge mortgage.

The pros of second charge mortgages
  • If your credit history isn't brilliant, but you need to borrow some more money, for example to pay for a home extension because your family has grown, it can be the cheapest option.
  • If you're self-employed and struggling to borrow from elsewhere, it can offer you a way to use your home as security to get a loan.
  • You can repay them over a long term, such as 25 years.
  • You may be able to overpay, although you should carefully check for any overpayment or early repayment penalties if you think this might be an option for you.

The cons of second charge mortgages
  • If your credit rating isn't good, you're likely to pay a higher rate of interest (40%+) on the second charge mortgage than for an ordinary secured loan.
  • More importantly, you could end up losing your home if you can't keep up the repayments.

What to watch out for
At the moment, second charge mortgages are regulated by the Office of Fair Trading (OFT) under the Consumer Credit Act. This means if you're borrowing less than £25,000, you have a 14-day 'cooling-off period' after you've signed the paperwork to change your mind.

The OFT also has guidelines that says a lender should give you time to carefully consider your options before you sign on the dotted line and there should be no pressure sales tactics.

Shop around
As with any financial product, it's important to shop around for a second charge mortgage. Make sure you ask upfront about any fees, charges or penalties so you can factor them in to the total cost of your borrowing.

Once again, you must be confident that you can afford to repay the mortgage each month or you're putting your home at risk.

If you need to borrow a smaller amount of money (under £25,000), you can repay it in five years or less and you have a good credit rating, you should consider other options such as an unsecured personal loan first.

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