With interest rates at their lowest level since 1955, the surge in remortgaging is expected to continue growing exponentially this year, and few advisers will want, or even be able, to talk clients into considering a different option with a higher rate. But, in some cases, this may be doing the client a diservice.
The tremendous growth in house prices has left many people with a substantial amount of equity in their property and remortgaging will free up some of this cash as well as reducing their mortgage rate. However, there are a growing number of borrowers for whom taking out a second charge on their property is actually a better option.
Most mortgage advisers know a second charge is registered when a second lender provides a further secured loan on a property that is already mortgaged. Therefore it is not the same as a remortgage product (where a borrower can take an alternative mortgage product) or a further advance, (where the existing mortgage lender tops up a borrower’s mortgage). But when explaining how these work to clients, it can be difficult to sell the concept so in some cases it can be useful to define a second charge in terms of a secured loan, with the monies secured on the property.
Although mortgage rates have been falling steadily for a number of years ‘ and are credited with the surge in remortgaging ‘ there is an element of higher risk with secured loan rates and so they will never be as low as mortgage rates. But this does not mean a secured loan is only an option for borrowers who would not be able to secure a remortgage on favourable terms.
Reading between the lines
Taking a second charge over a property clearly involves a greater level of risk for the lender and this will always be reflected in the rate charged. For this reason it makes sense to remortgage rather than take a secured loan in many cases. However, the true cost of getting finance depends on more than just a headline rate. It is, after all, best practice to always look at true cost comp-arisons before offering a client a product ‘ even when choosing between mortgages. The same principle applies to secured loans. That said, mortgage rates are extremely competitive and likely to remain so for some time. When this is combined with high property prices there is bound to be a large amount of remort-gage activity for both saving and raising money through the release of equity. But something else has happened too ‘ the secured loans market has been growing dramatically during this time.
The figures below show the following five-year trend for secured loans.
Period Lending (£m)
Source: Finance Leasing Association
It is interesting to note that between 1998 and 1999 there was growth of less than 10%, but the following year shows a leap of more than two-thirds. After that, growth has slowed again although it is still impressive. So what can have caused this phenomenon?
A number of factors are behind this growth, but one that stands out is the recession of the early 1990s when many people damaged their credit through defaults or county court judgements (CCJs). There is clearly a connection between secured loans and bad credit ‘ those who have bad credit stand little chance of getting unsecured credit and often turn to secured loans instead where acceptance rates are far higher. Also, with levels of personal debt so high many people will have damaged their credit since they last took out a mortgage, so a remortgage would mean moving the full amount of their debt on to a higher rate while a secured loan avoids this. But while the increase in bad debts automatically increases the size of the market, this alone is not enough to produce the growth seen in this market.
After the inflated mortgage interest rates of the early nineties many people remortgaged to lower rate deals, but many deals had overhanging redemption charges. A few years down the line rates are even lower while property prices have soared and many people want to release equity from their property to raise funds for whatever reason. One way to do this and avoid redemption charges is to procure a secured loan. The current mortgage is unaffected and the equity can be released without penalty.
Another major factor, which has been building for a number of years, is lenders’ attitudes to non-standard borrowers. More flexible lending terms have appeared for the rapidly-growing self-employed market and those with a bad credit history. It was not so long ago that unsecured loans and mortgage products for these people were few and far between and many people will have made good use of secured loans as the only real alternative.
Of course there are also people who have simply reached the limit of unsecured debt and need to consolidate. Secured loans are excellent for consolidation as they allow large amounts to be repaid at reasonable monthly amounts over a longer period, and in some cases they can be cheaper than unsecured debts such as store cards and credit cards. All of which can make life easier for borrowers and allow them to maintain their standard of living. In fact unsecured consumer debt has shown a dramatic rise which could mean there will be a big market for consolidation in the near future. Consumer spending has gone through the roof in recent years, and perhaps even helped to prevent a recession in 2001.
Market analyst, Datamonitor, says that five years ago the average credit card debt per person in the UK was £2,230. In December 2002 it had grown to £3,380 ‘ a 50% increase. And the total unsecured personal debt in the UK totalled £158bn at 18 December 2002. This clearly represents a change in public attitudes to debt and borrowing. What was previously a last resort not taken lightly ‘ and often with an element of shame attached ‘ has become a way of life.
This new way of life is not just for over-burdened, self-employed blue-collar workers. It applies across the board and throughout all social classes. The people that were targeted in the past ‘ the D demographic ‘ are not the sole target market any longer. There are now some lenders who will only deal with mainstream cases ‘ a strange reversal of the mortgage market which has moved ever deeper into complex and sub prime over the years.
Armed with this knowledge and the high procuration fees that are available in the secured loans market, it is no surprise that many new companies have entered the market. This, in turn, has provided further stimulus for growth.
So in certain situations, secured loans are perfect for borrowers and there are rich pickings for mortgage advisers, but what other benefits are there?
A key advantage of second charge loans is that unlike first charge mortgages, there are no costs incurred by the borrower such as valuation, legal or administration fees with a second charge. Applications can be progressed quickly, often on a one-page form with straightforward underwriting procedures.
Typically, second charge loans will carry a higher interest rate than first mortgages, with rates usually starting from around 7.7% APR. However, these are still lower than most other rates charged on personal loans. The amount of money a borrower can get with a second charge loan is not decided on the traditional mortgage calculation of income multiples, but rather the borrower’s ability to repay the loan. There are also more flexible plans available for self-employed borrowers who may have difficulty proving their income. This method of calculating the ability to repay means many borrowers will be able to borrow more than they might if they had tried to remortgage or obtain a further advance.
Second charge loans can vary considerably in size, with loans available from £3,000 up to around £50,000 ‘ although larger amounts are dependent on the individual circumstances. On loans of up to £25,000, the loans are regulated by the Consumer Credit Act, but they are not regulated above that amount. In addition, secured loans have been excluded from CP146, which is widely seen in the industry as a mistake. While no one likes red tape, given the new mortgage regulations there are fears there could be significant growth in the number of unqualified advisers actively selling second charge to replace their lost mortgage income. Whereas in many cases second charge loans may be the best solution for the client, there will continue to be cases where a first charge would be more appropriate. Consequently it is inevitable there will be times when customers are sold the wrong product. Fully-qualified mortgage brokers are in a better position to assess a client’s needs in borderline cases and choose which option is best.
This is a market that has the potential to become much more prominent than it is currently, whatever happens to house prices, but it is not suitable for everyone and so leaving it outside of statutory regulation could leave it open to claims of miss-selling. This should not put advisers off, as it can often be the right product to offer, but those selling the product must be confident the client fully understands why they are taking out a second charge and what it means.