Interest-Only Secured Loans: Mortgage Considerations

There may be times in life when you want a pot of money to finance ‘big ticket’ items such as home renovations, a holiday home or the holiday of a lifetime. In this case, many people may turn to interest-only secured loans as a means of financing it.

Whether or not you can get this kind of loan if you already have an existing mortgage is a common question. Here we look at exactly what an interest only secured loan is, its advantages and disadvantages and how such a loan may interact with your existing mortgage.

What is an interest-only secured loan?

A secured loan is one in which the debt is linked to an asset, usually a property. For this reason, secured loans are often referred to as homeowner loans. It is possible to secure a loan against other assets such as a vehicle or jewellery, but a property is by far the most common security for a loan.

An interest-only secured loan is a loan taken out against your home on top of your existing mortgage. Unlike most standard mortgages, however, you only repay the interest amount each month over a set period of time. At the end of this timeframe, the original capital amount borrowed has to be repaid in full. As such, an interest-only secured loan is a way of releasing money with fairly low monthly repayments.

There are three main types of interest-only secured loan available: –

• Fixed term- Monthly payments remain the same throughout the loan term.
• Variable rate- The interest you pay is based on the Bank of England base rate, therefore it can fluctuate.
• Short term fixed- Payments remain the same for a set time and after that move to the lender’s standard variable rate, which is dictated by the market.

I already have a mortgage, can I get an interest-only secured loan?

Interest-only secured loans are also known as second charge mortgages or homeowner loans. They are second charge mortgages because the first charge is the initial mortgage being paid against the property in question. Therefore, it is unlikely that you will get an interest-only secured loan without having a mortgage in place already on the property used as security. The loan money can be used for anything you wish but the most common uses are home improvements such as extensions, cars, holidays and weddings. Debt consolidation is another common reason people may take out a second charge mortgage.

Over recent years, interest-only secured loans or second charge mortgages have grown in popularity, as have interest only mortgages although both remain quite difficult to obtain. Just like an interest-only secured loan, an interest only mortgage involves paying just the interest on your loan amount each month. At the end of the term, you are required to repay the original capital amount you borrowed.

What happens at the end of the term?

Taking on an interest-only secured loan is a big financial commitment. While monthly repayments may be low, you will still be required to pay back the whole capital amount at the end of the term. You will need to create a strategy as to how you plan to do this before taking on the loan. Interest-only secured loans can be ideal for someone who knows they will be coming into money in the future either through a pension, a family inheritance or an ISA, for example. Another common repayment vehicle is selling the property at the end of the term and paying back the capital in that way.

What are the advantages of an interest-only secured loan?

– The main advantage of an interest-only secured loan is that you only have to cover the monthly interest, meaning much lower repayments.

– A secured loan is always seen as less of a risk than an unsecured loan, which means secured loan interest rates can often be more favourable.

– While unsecured loan repayment periods are usually capped at seven years, interest-only secured loan repayments can usually be stretched over a longer timeframe. They are typically set for 15 to 25 years.

An interest-only secured loan can be a good option for somebody who knows they are coming into a certain amount of money later in their life, allowing them to enjoy lower monthly rates now.

What are the disadvantages of an interest-only secured loan?

– While the lower monthly repayments make an interest-only secured loan very attractive, the capital amount still needs to be paid back in full on a set date. This could prove difficult if your repayment vehicle gets derailed along the way. Careful planning and caution are needed to make sure this does not happen. The repayment strategy needs to be revealed to the lender in advance of securing the loan so they can approve it. Research from the FCA previously showed that for interest-only borrowers who were set to repay their loan in 2020, just under half of them were modelled as being likely to have a shortfall [1].

– Interest only loans in the UK are not common and can sometimes be difficult to find. Free Price Compare can help you see what deals may be available to you.

How much can I borrow under an interest-only secured loan?

The amount that you can borrow will vary from lender to lender but can be anywhere between £10,000 and £1 million. How much you can borrow will depend on your personal circumstances and will be considered on a case-by-case basis. Interest-only secured loans can be difficult to obtain.

You will likely need to have a minimum amount of equity in your property to qualify for an interest-only secured loan. This can be calculated by subtracting what you owe on your existing mortgage from the value of your property. This will give you the loan to value (LTV) rate, which is used in part to decide your application. Most lenders have an LTV cap, which is usually between 50 and 80%.

You will also need to be able to demonstrate and provide proof of a viable plan for repaying the capital amount at the end of the term.

Monthly repayments tend to be lower on an interest-only secured loan, but lenders will still want assurances that you can pay them each month. They will get this by assessing your finances. Remember, however, your home is at risk if you do not keep up with repayments so never borrow more than you can afford.

Why not just remortgage my home rather than take out an interest-only secured loan?

Whether an interest-only secured loan or remortgaging your property is better for you depends on your own personal circumstances. Remortgaging a property involves taking out a new mortgage on a property you own. It can replace your existing mortgage or borrow money against your property. Breaking your existing mortgage may lead to fees and penalty charges which should be taken into account when making the decision. Remortgaging should certainly be explored as a potential option when considering ways to release more equity.

I am interested in an interest-only mortgage. Can I switch to one?

The main benefit of switching from a repayment mortgage to a mortgage only interest is paid is that it will bring lower monthly payments. It is possible to change, but you will need to ask your current provider if they are willing to allow it. This will be determined based upon your own individual circumstances and whether you have a suitable repayment vehicle in place.

If they are not willing to allow you to switch to a mortgage interest only product, you may have to remortgage with another lender who is willing to allow it. You may also be able to find better interest-only deals elsewhere, although it is worth remembering you may incur fees and charges for switching.

It is also worth remembering that with an interest-only mortgage, you are likely to pay more overall than you would with a repayment mortgage. This is because you make monthly payments – albeit lower than on a repayment mortgage – but still have to repay the capital amount at the end of the term. Your monthly repayments do not help you to reduce your debt.

Interest-only mortgages have had something of a chequered history. Before the financial crash in 2008, there were 73 lenders offering interest-only mortgages. By June 2013, there were just 12. However, in recent years the number of providers offering them has grown again. [2]

UK Finance believes that there were 754,000 interest-only mortgages outstanding as of the end of 2021, down by 17% from 2020 [3].

How do I know if an interest only loan is right for me?

An interest-only secured loan is a huge financial undertaking, which requires careful planning. Whether it is the right move for you depends on your own personal circumstances and finances. Having a thorough understanding of interest only loans, as well as other options available to you, will help you to make an informed decision. Take time to research how it would impact your repayments. An interest only loan calculator can be used to help you do this, but it is important to remember that while lower monthly payments may be attractive, the capital amount still needs to be paid in full. It may be a great option for those who know they have a lump sum coming to them further down the line.

An interest-only secured loan is dependent on you having a first mortgage on a property against which the loan is secured. This is different to an interest-only mortgage, which is a less common choice for homeowners in the UK.

Whatever you decide, Free Price Compare will show a range of potential secured loan deals for you, and help you explore mortgage options too. Simply tell us a few details about yourself and how much you want to borrow and our online tool will provide you with the best deals around within a matter of seconds. You will have access to quotes from dozens of lenders all in one place, saving you time and effort. We cover 90% of the market for second charge mortgages. You can also speak to one of our specialist secured loan advisers to discuss what might be the best option for you. You can get help and advice free of charge and with no obligation.

Remember that if you fail to make repayments on your second charge mortgage, your home is at risk and could ultimately be repossessed. If you are struggling with repayments, speak to your lender. If you are struggling with finances and need free and impartial advice, you can call Money Advice Service on 0800 138 7777 or Citizens Advice Bureau on 0800 240 4420.

References

• [1] www.fca.org.uk
• [2] www.which.co.uk
• [3] www.ukfinance.org.uk