When a client wants to raise cash from their property, the usual course of action is to find a low interest rate solution and remortgage. It is a discussion that happens hundreds of times of a day across the country, but while the obvious course of action is to remortgage, in some circumstances it can be more advantageous to the client to recommend a second charge. In these situations clients may want to use the funds to consolidate debt or to fund a holiday, home improvements or even a new car, but their personal situation decrees that a secured loan may be cheaper than remortgaging.
A second charge loan, otherwise known as a second charge mortgage or secured loan, is borrowing which is secured against an already mortgaged property, taken out for a non-housing buying reason.
A client wishing to raise capital against any equity in their property, for the purposes outlined above, has two basic options open to them: either to remortgage their existing property, or take out a second charge loan. Both these options have benefits and drawbacks. On first inspection, it may seem difficult to see why a second charge loan would be the best option for a mainstream client, given that it will almost certainly be at a higher rate of interest than a further advance. However, there are particular circumstances where a second charge loan would be the best approach to take.
Catering for adverse credit
One of the most important points to make about the second charge market is that it predominately caters for borrowers with some level of adverse credit. It may be that these borrowers are currently paying higher rates of interest on their mortgage than those borrowers who fall into prime or mainstream lending categories. For these customers, second charge loans may be a way of borrowing additional money against the equity on their property at a lower rate of interest than if they were to remortgage their existing debt.
As a product aimed at borrowers with an adverse credit history, second charge loans may be one option if their applications for personal loans have been refused previously.
But second charge loans may also be an option for borrowers without an adverse credit history. Borrowers may wish to use any existing equity to take advantage of the low interest rate environment to enhance their quality of life or make improvements to their home. However, while with another mortgage the interest rate may be low compared with other borrowing such as personal loans and second charges, there is no flexibility regarding the length of the term if it is connected to the existing mortgage. Potentially the client might have to repay the additional borrowing over a long period depending on the remaining mortgage term. This may be acceptable if the borrowing is for home improvements, however, if a mortgage has 17 years to run any additional borrowing will have to be repaid over that term. So the question is: is that the best way to finance a car or a holiday? In many cases, it may not be appropriate to finance a short-term expense over the long term.
Time is of the essence
Another key benefit of second charge loans is that they can be processed relatively quickly. They require no up-front legal, valuation or survey fees so tend to be a time-efficient option. This time-factor is especially important to those borrowers who have been refused loans and remortgages before applying to the second charge lender.
A second charge loan may also be the best option for a client who wishes to raise money against the equity in their property via a remortgage but is still in the initial redemption fee period. In this situation, if the cost of redeeming the mortgage is greater than the interest costs associated with a second charge loan, then the latter option may be advisable.
Nevertheless, it is important to point out the client must be given the widest possible choice in terms of options, so in some cases, remortgaging is the better option.
It has been widely reported that remortgaging is still on the increase, and figures from the Council of Mortgage Lenders (CML) bear this out. Recent CML reports show total mortgage lending reached £219bn in 2002, with remortgaging accounting for 38% of that total at £83.6bn.
The reasons behind this increase in remortgage business include the low interest rate environment, a sound economy with low unemployment levels and intense competition between mortgage lenders to try and encourage borrowers to switch to deals with better interest rates.
But it is not just remortgaging that is on the increase. According to market analyst, Datamonitor, gross advances in the UK secured loans market increased to more than £14bn in 2002. The growth of unsecured debt is fuelling an increase in the secured loan market as customers look to consolidate existing unsecured debts. One prediction put forward by Datamonitor is that gross advances in the secured loan market could amount to more than £22bn by 2007, even if growth seen in recent years slows to a more sustainable rate.
As a result, traditional first charge and mortgage companies are now moving into the secured lending market, which already includes names such as Freedom Finance and Purple Loans. However, this increase in second charge borrowing needs to be seen in the context of consumer debt as a whole. The growth of the market is part of a trend of ‘indebtedness’ where secured loans are in higher demand among those already in debt.
Consequently it is of some concern that second charge loans are to be excluded from statutory mortgage regulation when the Financial Services Authority (FSA) takes control in 2004. The main question that needs to be addressed is why second charge loans were excluded from this proposed regulation. Should second charge loans be regulated alongside unsecured personal loans under the Consumer Credit Act (CCA) ‘ as is currently the case ‘ or should they be regulated alongside mortgages under the impending regulation being brought in by the FSA? Consultation Paper 146 currently excludes second charge loans, but few seemed bothered as only two organisations wrote to the FSA highlighting the omission of second charge mortgages during the consultation process.
Second charge inclusion
It is the opinion of many in the lending industry that second charge mortgages should be included in the FSA regulation that is to govern mortgages and remortgages, and not under regulation provided by the CCA that governs unsecured personal loans. This is mainly due to the fact that they are a charge secured against property so borrowers can lose their homes if repayments are not made. It appears that the Government has sought only to bring the borrowing associated with house purchase under the regulation as it thinks this is where customers need protection. And this would explain why second charge loans are not part of the regulatory regime. However, CP146 does not exclude remortgage borrowing, which in many cases has nothing to do with the purchase of a property.
As has been mentioned earlier, second charges are currently covered by the CCA, but many argue that this is inadequate and out of date. It is currently being reviewed, so any changes will have an impact on the secured lending market.
Impending regulation will ensure that all intermediaries will have to be appropriately qualified to give advice on mortgages and remortgages, and that such advice will be regulated by the FSA. Because second charge loans are excluded from this regulation, brokers who deal with this type of borrowing will not be liable to the same regulatory constraints and standards. The possibility that some non-qualified brokers would seek to offer only second charge loans due to their position in the regulatory framework should be a cause for concern, as they will not be able to provide the range of products their clients need in order to choose the most appropriate option.
It has been suggested that in the future flexible mortgages will have a negative impact on the growth of secured lending. The rise in popularity of flexible mortgages could theoretically reduce the need for second charge borrowing because mortgage holders would use the drawdown facilities built into the mortgage instead of seeking additional loans. However, flexible mortgage products are aimed at a different consumer group ‘ one without any adverse credit ‘ so it is uncertain that they would have a major impact on second charge loans. In fact, second charge loans are historically marketed to those with adverse credit profiles and lower income borrowers.
Datamonitor figures suggest this market will grow, despite the growth of flexible mortgages as borrowers continue to use equity in their homes to consolidate existing unsecured lending.
Therefore it would make sense if all mortgage-related lending, including second charge loans, should be brought together under the same regulatory framework to ensure best advice for the best consumer. And second charge loans should only be offered as part of a wide choice of capital raising products as they are not the ideal solution for all borrowers.
It would only be detrimental to the industry if some mortgage advisers chose to only offer clients access to second charge loans in isolation because they were not authorised to offer advice on mortgage and remortgage products.