Everything you want to know about homeowner loans is right here. This guide has packed in all the fine details about this type of secured loan that rewards you for making ongoing repayments on your mortgage and building your home equity.
You should think carefully before securing a debt against your family home, but when done with consideration, it can be a beneficial credit option.
What are homeowner loans?
A homeowner loan is a type of secured loan that uses your home equity as collateral in the event you fail to keep up repayments. Thus, you need to be a homeowner with sufficient home equity to get a homeowner loan.
There are multiple terms to describe a loan secured against home equity. You may also know them as home equity loans and second charge mortgages. Only ever apply for one of these products from a bank or lender that is authorised and regulated by the Financial Conduct Authority.
What is a secured loan?
If you’re not sure what a secured loan is, let us clarify it for you. A secured loan lists an asset or assets within the credit agreement as collateral if you do not pay your monthly repayments in full and on time. If you default on the agreement, the lender can seize and sell your asset to raise money and clear the debt.
Therefore, secured homeowner loans use your home equity as collateral and you could lose your home if you do not stick to the agreed monthly repayments. Agreeing to additional debts against your home can go wrong. This is why you should think carefully before securing a loan with a property or home equity.
How do homeowner loans work?
Secured homeowner loans work by providing the homeowner with a lump sum amount borrowed against their home equity. The person applying for the loan will need to have enough home equity to be able to take out a homeowner loan.
After the lump sum has been paid, the homeowner must pay monthly repayments consisting of a repayment on the principal amount and interest for an agreed period. The total amount you repay will therefore be more than what you borrow.
There is one exception to this process. A home equity line of credit (HELOC) is a variation of a home equity loan and works differently. The HELOC includes a draw period where the homeowner draws money from their loan as they need and then principal repayments only begin after the draw period ends.
How much could I borrow?
The amount you can borrow using a secured homeowner loan is determined by multiple factors:
- Your home equity
- The lender’s maximum LTV ratio
- Your personal finances
- Your credit score
The lender’s loan to value ratio (LTV) and the amount of equity in your home will set the limit on how much you could borrow with a secured homeowner loan.
The LTV ratio is how much the lender will let you borrow against an asset. In this case, it is the value of the loan against the value of home equity. On average, lenders offer LTV ratios around 80%. This means if you have £100,000 home equity, the absolute maximum the average lender would allow you to borrow is £80,000. And if you have £50,000 home equity, the absolute maximum you could borrow would be £40,000.
We say this is the maximum because there may be personal circumstances that prevent you from accessing the maximum amount. You might have an unsatisfactory debt to income ratio (which would take into account your first mortgage payments!) or your credit score may be lower than normal.
How can I calculate my home equity?
It’s quite easy to calculate your home equity. All you have to do is subtract any remaining debts against your home from the current property value. For most people, this will simply require taking off the existing mortgage balance away from the value, but if you have additional debts secured against your property, you will also need to take away these amounts from the home’s value.
For example, if your home is now worth £250,000 and you have a £125,000 mortgage then you have £125,000 home equity (50%). If you already have a home equity loan of £30,000 then this would need to be subtracted as well, giving you £95,000 home equity.
The only difficult part is knowing what the value of your property currently is. Many people just use the price they paid for their home, but the value of your property may have changed even over a short period.
How long do I get to repay?
Homeowner loans are typically advertised with repayment periods from a year to 35 years or more. The length of time you need to repay your homeowner loan will affect the interest rate you’re offered.
Most lenders provide a homeowner loan calculator where you can change your repayment period and see how the representative interest rate changes. Be aware that these calculators are only based on 51% of applications with a representative example and do not take into account income, credit history and your credit score.
The pros and cons of homeowner loans
- Access more credit than other loans
- Can be used for many purposes, including debt consolidation and home improvements
- Potential to get a lower interest rate than other options
- Avoid early repayment charges when refinancing a mortgage (alternative option)
- Your home is at risk if you miss monthly payments
- Securing other debts against your home will take longer to own it
- Additional loan fees and charges are possible
Who is suitable for a homeowner loan?
To be eligible to apply for a homeowner loan or any other secured loan where the loan is secured against equity, you need to have enough home equity in the first place.
Many secured homeowner loans set a minimum amount you must borrow, typically around £10,000. And because you cannot borrow against all your home equity, you’ll need more than this to borrow at least £10,000. You’ll also need to be of a certain age and live in the UK for most of the year to make you a UK tax resident.
The above just makes you eligible to apply. To be approved your finances will need to be assessed. This is to ensure you can afford the loan and to prevent a situation where your home may be repossessed.
What can I use a homeowner loan for?
The sum of money you receive from taking out a homeowner loan can be used for an array of purposes. One of the most common reasons people want to borrow is to complete expensive home improvements, such as a new kitchen, bathroom or loft conversion.
Another common reason is to consolidate existing debts, such as personal loans and credit cards owed to other creditors. By merging them into a homeowner loan with a lower rate of interest the homeowner could make managing monthly payments easier and save some money in the process. You can learn more about debt consolidation here.
But that’s not all, you could want to borrow with a homeowner loan to:
- Help pay for a holiday home
- Help family members buy their first home
- Pay for private medical costs
- Pay for private schooling or university education
- Go on a round-the-world trip
What fees are involved when taking out a homeowner loan?
Taking out a secured homeowner loan involves more fees than the interest payable. You might be subject to one or more of these additional charges:
- An arrangement fee – this is a lender fee for arranging the loan
- An appraisal fee – you may end up paying this to value your property
- Broker fee – a fee paid to the broker if you use one
- Early repayment charge – the repayment terms may require you to pay a fee for clearing the loan amount early
- Closing costs – some loans include costs when you finish repayments
It’s essential that you check the repayment terms of your proposed credit agreement to fully understand what the overall cost of the loan would be. This will also help you to compare loans accurately.
What is the interest rate of a homeowner loan?
Secured homeowner loans can be offered with a fixed or variable rate of interest. The interest rate you’re offered will be determined entirely by personal circumstances. In general, the lower interest rates are reserved for secured loans while unsecured loans because the lender views you as less of a risk when you are using an asset as collateral.
A variable interest rate will be determined by the Bank of England’s base rate and then the additional rate added by the lender. It adds the two together and can change over time depending on how the economy is performing.
But in a nutshell, it is not possible to state what interest rate you will get when using a homeowner loan.
Where can I get a homeowner loan?
You can find homeowner loans advertised by a string of UK loan providers and creditors. You’ll see them offered by the biggest banks and building societies, and you’ll also find them advertised by online banks and online lenders too.
Whether you’re looking for an unsecured loan or a secured loan, always make sure the lender you’re applying to is legitimate and regulated.
How should I compare homeowner loans?
You can compare homeowner loans by searching for them online and checking out each individual lender to see what they’re offering. This process can be time-consuming but it is made easier with homeowner loan calculators. These are financial calculators built into their website that help you add what you want to borrow and see what your repayment could be.
The important word here is “could”. These calculators use a representative rate that may not be what you are offered.
Should I use a credit broker?
A credit broker is a company or agency that helps you find the loan or mortgage that is suitable for you. Some services can be extremely helpful if you struggle to understand what to look for when comparing secured loans. And they may even submit your application for you.
However, using these services comes at a cost. You may need to pay a broker fee or ongoing commission if you take out a loan with one of the lenders they found for you.
Some brokers do not easily reveal that they are just a broker and you may be tricked into thinking you’re applying directly with a lender. If you deal with a broker not a lender directly, you could be paying more than you need for that loan.
How long will it take to receive my homeowner loan?
Applications for homeowner loans can be assessed and provide a decision within a few days. Secured loans of this kind may require an appraisal of your home to work out an accurate market valuation and therefore correctly calculate your home equity. If this is needed, the period of time required to make a decision on your application will be longer.
However, once your application is approved you can expect the loan amount to be in your nominated bank account within a few days. If you’ve taken out a loan with a bank where you already have a current account, the bank might be able to provide you with the loan amount on the same day you’re approved.
Are homeowner loans easy to get?
Homeowner loans are only easy to get approved if you meet the eligibility criteria and you are seen as having low lending risk. If you have an unsatisfactory credit score or multiple existing debts then it can be difficult to get one.
You can find homeowner loans advertised by a host of lenders which does give UK residents plenty of options when seeking this type of credit agreement. Make sure you’re searching for home equity loans and second charge mortgages to cover all bases.
Can I get a homeowner loan with bad credit?
It’s not impossible to get a homeowner loan with bad credit, but it is more difficult. Just like any other secured or unsecured loan, getting approved with an unsatisfactory credit rating can result in rejection.
Yet, there are still many lenders around willing to lend to people with a low credit score. You may be able to borrow but you may be subject to less attractive repayment terms.
Check your credit score first!
Before you apply for a homeowner loan in the UK, make sure you check your credit score. You can do this for free with many credit reference agencies with a free trial. Create a reminder to cancel your subscription within the trial period or you could be stuck in an expensive contract you don’t need.
If your credit score is not as good as you thought it was, there may be some quick fixes you can do before applying. Or you may prefer to improve your score over a longer period and then apply after.
Quick ways to improve your bad credit rating
Most of the methods used to improve a credit file take time to make a difference. But there are two things you can do to improve your score quickly.
The first is to register on the local electoral register. By registering to vote in local elections it makes it easier to verify your identity. Doing so helps the credit reference agency and boosts your score a little, which could make a big difference.
The other method is to look for mistakes on your credit file. Some experts even predict that around 20% of the population have a mistake on their credit report at some time. With such big percentages experiencing mistakes, you should be looking too.
If you do spot an error, you should first make contact with the entity that has made the record and ask them to remove it, which would increase your score. If they do not respond in good time or agree to remove it, you can then ask the credit reference agency to do it for you. You’ll need evidence that it is a mistake.
Can I get an unsecured homeowner loan instead?
Those who do not have enough home equity – possibly because they just bought the property through the government’s Help to Buy Scheme – can consider an unsecured homeowner loan instead.
These loans don’t work like other unsecured loans because unsecured homeowner loans usually require a guarantor. You are likely to need a guarantor who agrees to pay the loan if you don’t keep up with monthly payments.
The loans are secured with the guarantor’s commitment to paying, but they may also require the guarantor to add their own assets as collateral within the credit agreement. So, even though they are called unsecured homeowner loans, they are still secured by the guarantor.
Need more help understanding secured loans?
If you want to learn more about secured and unsecured loans, especially homeowner loans and second charge mortgages, come back to MoneyNerd again soon. We have guides covering all aspects of these loans with top tips on how to look for them and which lenders to consider. You may be able to borrow in ways you never thought possible.