Getting a second mortgage is a big decision for you and your family. It might be one of the best and possibly cheapest ways of securing large amounts of credit, but it also comes with significant risks. If you’re thinking about getting a second mortgage secured against home equity, this is the complete guide for you.
We touch on all aspects of second mortgages so you’re fully in the know before proceeding to a decision. Read on for more!
What is a second charge mortgage?
A second charge mortgage is a type of loan that is secured against the equity in your property, whilst you already have a residential mortgage on that property. The first charge mortgage was taken out to help you buy the house or flat in the first place, and the second charge is a secured loan using your home equity as collateral. Interestingly, if you were to take out a third or fourth loan against your home equity, these would also be called second charges – rather than third and fourth charges respectively.
To understand a second charge mortgage correctly, you’re going to need to know what home equity is and how to calculate it. The equity in your property is the difference between its current market value and any debts secured against your home. For most people, this will just be their current mortgage used to buy it. The equity in your home increases as you make mortgage repayments, as long as the property value does not decrease.
A second charge mortgage is also called a home equity loan or secured homeowner loan. Only consider taking out a second mortgage offered by a bank or loan provider that is authorised and regulated by the Financial Conduct Authority.
What is an example of a second charge mortgage?
Let’s imagine John and Jade bought a house worth £200,000 seven years ago. They needed a mortgage to help them buy the property and have been making regular monthly repayments ever since. Over time, they have paid off a chunk of their mortgage and only owe £90,000 in total. During these seven years, their property has increased in value by 10%, making it now worth £220,000.
So, they have a home worth £220,000 and a £90,000 mortgage remaining, giving them £130,000 home equity. John and Jade want to add a conservatory to their home that will cost £40,000. They decide to take out a second charge mortgage of £40,000 loan using their home equity as collateral to pay for the conservatory upfront and make repayments afterwards.
They will have to make repayments on their existing mortgage and the second mortgage separately. This is the case even if they have both mortgages taken out with the same lender. Repaying all of either the first mortgage or the second mortgage early could result in an early repayment charge.
Second charge mortgage vs second mortgage
A second charge mortgage is also known as a second mortgage. However, using the latter term can cause some confusion because some people may refer to a second mortgage when they want a second first charge mortgage to buy a second home, maybe as a buy-to-let investment or holiday home.
Throughout this guide, we will use the terms interchangeably to refer to loans secured with the equity in your home.
How does getting a second mortgage work?
Getting a second mortgage will provide you with a lump sum that is repaid over an agreed period of time, which could last from a couple of years to decades depending on your income level and size of the loan. These repayments consist of a repayment on the principal amount – i.e. the amount you borrowed – and a payment of interest as stated in your credit agreement.
Second mortgages are also known by other names, including a home equity loan and secured homeowner loan. These both work in identical ways to what is described above. But there is another type of second charge mortgage that is not the same as above, namely a home equity line of credit (HELOC).
A HELOC provides the homeowner with a loan secured against equity, but it is not paid out as a lump sum. The homeowner can draw down on the loan over a period aptly called the draw period – a bit like using a credit card. Repayments aren’t made on the principal amount until after the draw period, but you do pay interest during it.
Does getting a second mortgage put my home at risk?
A second mortgage is a type of secured loan, and therefore, the asset being secured is at risk if you do not keep up with repayments on this new mortgage. Because a second mortgage uses your home equity as collateral, your home may be repossessed if you have multiple missed payments. The lender will then sell your home to recover the debt and any arrears owed.
But things are not that simple. As two mortgages are on the property, when the property is sold to repay the debt, the priority goes to the first mortgage lender. The first mortgage is paid off from the funds before the second mortgage provider is able to put its hand into the pot to recover its debt owed. If the property was sold for a fair price there should be a small amount of money left for the ex-homeowner.
However, if the property sold for less than expected because its value has decreased, there could even be a shortfall on the second mortgage debt. This can be a serious situation depending on the size of the debt, and it could even lead to bankruptcy. Paying all your mortgage payments on time avoids this situation completely.
How much can I borrow?
The amount of money you can borrow when taking out a second mortgage depends on multiple factors. The first is the amount of equity you have. You won’t be able to borrow against all of your home equity because this presents risks to the lender and a negative equity risk to the homeowner.
How much you can borrow against your equity is capped by the lender’s loan to value ratio, which is typically around 80% max. For example, someone with £100,000 home equity could in theory take out a second mortgage for up to £80,000. However, the loan to value ratio may decrease if you are judged to not be able to afford such a loan, or if you have bad credit.
Why are people getting a second mortgage?
A second charge mortgage provides money that can be used without restrictions. Therefore, you can spend the money on anything you wish from flashy cars to sun-drenched holidays.
Most homeowners consider a second charge mortgage if they need to complete home improvements, such as renovating a specific room, converting a loft or even adding an extension. Doing so is likely to increase the value of the property and therefore increase your home equity again.
Along with home improvements, consolidating debts is another common use of a second charge mortgage. This is when the money from the second mortgage is used to pay back other debts, such as a personal loan or two and credit cards. The benefit of this is to streamline repayments and make managing finances easier with less chance of further defaults.
But more importantly, it is to reduce the amount of interest paid on the debts by choosing a second charge mortgage with lower interest in comparison to the credit cards and personal loan interest. You might have to take other things into account to see if second mortgage debt consolidation will save you money, such as an early repayment charge on a loan that could make it more expensive.
Does it cost to get a second mortgage?
There are not likely to be charges when applying for a second charge mortgage, but if you are approved and decide to go ahead with the loan, you might be subject to some fees.
There could be a loan fee for setting everything up, and there may need to be an appraisal fee to value your home and calculate home equity. The end of the second mortgage could include closing costs as well, which can be expensive. You should take these into account when comparing different second mortgage lenders and what they have to offer.
Speaking of comparing second charge mortgages, you could consider using a mortgage advisor or credit broker service. These professionals will search the market to find second mortgages that meet your needs and help you make a beneficial decision. However, using a service to compare second mortgages will come at a cost as well. Alternatively, you can search and research options independently online.
The pros of getting a second mortgage
The benefits of getting a second charge mortgage might not be the same for everyone, but the generally accepted pros are:
- You could get a loan of a greater amount compared to anywhere else. Secured loans can usually provide bigger loans because an asset is used as security. A property and home equity is the most valuable asset that can be used as collateral and therefore opens the door to the potential for a bigger loan.
- Secured loans are known to provide competitive interest rates because the lender feels more secure knowing it is easy to recover arrears with the asset listed as collateral. Thus, second mortgages can offer competitive interest rates depending on individual circumstances.
- As mentioned above, the funds can be spent on an array of purposes as desired, from purchasing buy-to-let properties to a new bathroom.
- As you simultaneously keep your existing mortgage, you avoid any early repayment fees that could be applied if you remortgaged/refinanced the mortgage against home equity instead.
The cons of getting a second mortgage
The cons of getting a second mortgage are:
- Your family property is at risk if you lose your job and cannot repay
- Your home is at increased risk of negative equity if your borrow large amounts and your property value decreases
- You might have to pay more fees and closing costs
How to apply for a second mortgage
You can apply for a second charge mortgage either online or in-person at your local bank, providing the bank offers these loans. You’ll need to meet the basic eligibility criteria first, which means being of a certain age, live permanently in the UK, and that you already have a mortgage and home equity.
You’ll need to supply information about your regular income and your ongoing debts, including your first mortgage. They use this information to determine if the second charge mortgage will be affordable and to calculate how risky it is to lend to you. All applicants will need to provide permission for the lender to search their credit history as well.
Is it a good idea to take out a second mortgage?
Taking out a second mortgage is neither a good nor a bad idea. It all depends on personal circumstances and what other credit options are available for the amount of money you need to borrow.
Second mortgages can be advantageous for homeowners who need to borrow large amounts that are not available using other unsecured or secured loans, or they may just provide homeowners with a lower interest rate than they can get elsewhere.
Before settling on this option, you may want to consider:
- Other secured loans
- Unsecured loans
- Debt consolidation loans
- Home improvement loans
- Equity release (for seniors)
Is it easier to get a second mortgage the second time?
If you have had a second charge mortgage before and now need another one, the ease or difficulty of getting one the second time around is negligible. You might have a somewhat better chance if you stuck to repayments on the first one because this will have boosted your credit score. However, all your updated finances and debts will need to be assessed and deemed affordable.
How long does it take to get approved for a second mortgage?
Getting approved for a second charge mortgage can take a few working days to a couple of weeks. The process can be slowed down if the lender needs to complete an appraisal of your property to work out its accurate valuation and therefore your home equity. Once the second mortgage has been approved, the funds are usually transferred to your account immediately and show up within one or two working days.
You might see some lenders advertising fast second mortgages, but these could not be any quicker than using mortgage lenders that don’t advertise mortgages based on the speed of processing.
Can I get a second charge mortgage with bad credit?
You might still be successful in taking out a second charge mortgage with a bad credit rating as long as you have passed the affordability checks.
Secured debts like these are somewhat easier to get if your credit rating is just a little below what is expected. Some lenders even advertise second charge mortgages for people with a low credit score. But you might be offered higher interest rates.
A severely low credit score could mean not being able to take out a second mortgage.
Food for thought before getting a second mortgage…
This guide was written to break down every aspect of getting a second mortgage, but there are other things to consider and you might have a question that was not covered above.
MoneyNerd has recently published a wide range of new articles and guides all about second mortgages, answering niche questions that you could have too. Search our site for your query and see if we’ve just answered it.