How does a second charge mortgage work and what do I need to do to get one?

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Second charge mortgages are a second secured loan on a property. You must be an existing homeowner to get one and use equity in your property as security.

They're used as an alternative to remortgaging for various reasons but you should consider the risks carefully before applying.

What are the differences between a second charge mortgage and remortgaging?

A second charge mortgage is another name for a homeowner loan.

Like remortgaging, it is a form of secured lending because the borrowing is secured on the equity you have in your home. However, it is a loan not a second mortgage. If you take one out you will have both a mortgage and a secondary loan, all secured against your property.

A second charge mortgage is separated from your main mortgage. As the name suggests, repayments are second in priority to your main mortgage and you would normally borrow from a separate lender.

Remortgaging is the process you go through when you are negotiating a new deal on your main mortgage, for instance, when you come to the end of the term on a fixed rate deal.

A remortgage is when you extend your main mortgage, maybe borrowing more but all repayments are under one mortgage and there is not a separate loan involved. This can make budgeting and managing repayments more straightforward.

It doesn't always suit borrowers to remortgage. For instance, if you have a very low lifetime base rate tracker mortgage you may not want to lose this deal by remortgaging, in which case taking out a second mortgage may be a better option.

Tougher lending rules mean it's not always easy to borrow more money from your existing lender.

Rising house prices have left many households with stretched finances, and to fund improvements like extensions, you may need to borrow more. If you can't borrow from your original lender, you'll need to find an alternative.

If your credit rating has dropped since you took out your original mortgage, remortgaging might mean you pay a higher interest rate on your whole mortgage. A second mortgage means you'd only pay a higher rate on the extra amount you're borrowing.

Also, if you're mid-way through a fixed rate deal, you may face high penalty exit fees by remortgaging, so a second mortgage might be cheaper.

How much can you borrow?

This depends on how much equity you have in your property.

Equity is the proportion of the property that you own outright. So, if your home is worth £300,000 and you have a mortgage of £140,000, that leaves you with £160,000 equity, which is the maximum amount you can borrow on a second charge mortgage.

All mortgage lenders must follow strict lending rules and affordability checks on how much they can lend. Lenders must undertake 'stress tests' on your finances before deciding whether and how much to lend to you and you must show evidence you can afford to repay the loan before they agree to lend.

How do you apply for one?

You must be a homeowner with sufficient equity in your property to use as security for second charge borrowing.

When you take a second charge mortgage out you need to inform your original lender but your first charge mortgage is unaffected.

There are specialist lenders for second charge mortgages but the market is growing with more options becoming available.

What are the benefits?

  • Second charge mortgages provide borrowing options for people whose circumstances have changed from when they got their main mortgage. For instance, if your salary has dropped or your credit rating has fallen, you may not be able to borrow from your existing mortgage lender.

  • Second charge mortgages are also a good potential option for borrowers who've had payment problems due to redundancy or illness and can't borrow more from their original lender.

  • Greater competition in the market means loan rates have fallen but they're still likely to be higher than for your main mortgage. If you have a good credit rating you could pay just 4%. If you've had problems in the past it could be nearer 15%.

  • Some lenders let you make overpayments or even pay the whole loan off early without charge.

What are the disadvantages?

  • A second charge mortgage is still a mortgage so if you miss repayments, your home is at risk.

  • If you sell your home, the first charge mortgage is paid in full first and then you'll need funds to pay off the second charge mortgage or transfer it to a new mortgage.

  • Avoid second charge mortgages if you're struggling with repayments on your main mortgage. Borrowing more money is likely to only add to difficulties.

  • Think seriously about using a second charge mortgage to repay smaller debts, like credit cards, because the term can run for up to 25 years so you'll end up pay much more interest over the long-term. And remember, it's risky to convert unsecured loans into secured credit because it opens up the risk of repossession.

What are the alternatives?

If you need to borrow money but don't feel comfortable taking out another secured loan, there are alternatives. You could:

  • Remortgage: If you can increase the amount you're able to borrow on your main mortgage without penalty, this should be cheaper.

  • A personal loan: Good for short-term borrowing between £1,000 and £25,000 or consolidating credit card debts. Rates are historically low and repaying over a shorter period means you avoid high interest charges.

  • Credit cards: Get an interest-free deal and repay it without incurring interest, which makes it a good option for small expenses.

  • Bank overdraft: Only good for borrowing for very short periods as interest is usually high.

What to consider before taking one out

Carefully consider the costs of each option to decide what's best for you. Calculate whether you can afford to repay two mortgages because if you miss payments on either, your home could be repossessed.

If you're unsure, get advice from a financial advisor to help you find the right loan for your circumstances.

Talk to your existing lender and see what they would charge you for taking out an additional loan. If you've plenty of equity in your home, rates might be good. If you're looking elsewhere, shop around and compare the total cost, mortgage terms, fees, early repayment charges and interest rates.

With all mortgage borrowing, you should assess how you would manage repayments if interest rates went up.