What do you need to know about secured loans?

A secured loan is often referred to as a homeowner loan or a second charge mortgage.

The most important thing to know about secured loans is that they provide security for the lender, not for the borrower. In order to qualify for a secured loan, you need to be able to offer the lender something substantial in terms of value as collateral – usually your home – and by doing so, you enter into an agreement that should you default on payments, the lender can then sell your home to reclaim the money owed.

Because your home is at risk, you should only take out a secured loan if you are absolutely certain that it is the only way for you to access the money you need at a rate you can afford and that you can definitely pay it back as agreed, even if your circumstances were to drastically change within the term of the loan.

Why do people take out secured loans?

It’s a good question – given the high level of risk to the borrower, it’s somewhat surprising that the number of people taking out secured loans in the first quarter of 2022 has increased by 82.62% compared to the same period last year [1]. The data suggests that most people that took out a secured loan did so to consolidate existing debts with only a few borrowing the money in order to undertake home improvements or to add value to their property.

It is important to remember that although consolidating debts over a longer period of time means that you will pay less each month, you will be paying interest for a longer duration and this is very likely to increase the amount you repay in total.

Generally, people will take out a secured loan rather than a personal loan if they have a poor credit history which limits what a lender will offer them as an unsecured loan, if they need a larger sum of money than is available through a personal loan, or if they wish to take out a loan over a long time period. Often you can get very attractive interest rates for secured loans as the risk to the lender is much reduced.

Traditionally known as a homeowner loan, and available only to homeowners due to the need to use the house as collateral, secured loans were billed as being a way of paying for expensive building works or home improvements such as new kitchens and bathrooms which would add value to the property, allowing the loan to be repaid at such time that the property was sold.

Because of the risk to the borrower, taking out a secured loan should always be a thoroughly considered decision, and Martin Lewis, the Money Saving Expert, advises against doing so at all [2].

If you have unmanageable debts and are considering taking out a secured loan as a way of consolidating them, there are organisations such as the Citizens Advice Bureau [3], the Money Advice Service [4] and StepChange [5] that can help and support you to find alternative ways of managing your debt and these should be investigated before taking on further borrowing.

How Does A Secured Loan Work?

A secured loan works in principle the same way as any other loan. You make a request to the lender for the money, and through the application process, provide the necessary personal information which will include disclosing the purpose of the loan. The lender will perform all necessary credit, affordability and anti-fraud checks before agreeing to lend you the money.

The loan has to be repaid in accordance with the loan agreement and will include interest which will either be a fixed or variable rate, in line with the Bank of England interest rate. Because the Bank of England rate can go up and down, you should be absolutely certain that you could afford your repayments if the interest rates were to rise significantly before taking out a variable rate secured loan. It is much safer and easier to plan repayments with a fixed interest rate as this will not change for the duration of the loan.

Should the borrower fail to make payments, the lender can repossess and sell the house, or other valuable item provided as collateral, to reclaim the money owed. This process may also leave a County Court Judgement on the borrower’s credit history which will make it far harder for them to ever borrow money or take out another mortgage in the future.

How Can I Make Sure I’m Getting The Best Deal?

By entering your details into Free Price Compare, you will be contacted by a specialist advisor from the Loans Warehouse who are an FCA Regulated company. They will take further information from you and compare deals from across the market in order to help you to select the loan which looks best able to satisfy your requirements. This service only conducts a “soft” credit search which will not impact on your credit score.

In order to access the most attractive deals, you should have a significant amount of equity in your home and a good credit history. Equity is defined as the value of the outstanding mortgage that you have, deducted from the property’s value. For example, if your property is worth £150,000 and you have a balance of £100,000 outstanding on the mortgage, your equity in the property is £50,000. Generally the greater your level of equity, the more likely you are to be offered attractive rates as you will be considered lower risk by the lender.

Before applying for a secured loan, it is highly recommended that you check your credit score [6] to ensure that it is free from errors, allowing you to make any necessary changes before applying.

Should I Take Out A Secured Loan?

If you are absolutely certain that you have explored all funding avenues and that a secured loan will be a manageable, affordable expenditure which will allow you to achieve your aims (for example, making modifications to your property to allow you to live in it longer, or increasing its value to sell) and you are comfortable taking on the risk of the property being held by the lender as security against the loan, then you can proceed by speaking with a specialist advisor who will be able to answer all of your questions, provide you with a range of options including interest type, term, arrangement fees, early repayment charges and overall repayment amount which will allow you to make a fully informed decision.

To ensure you are entirely confident that a secured loan will be affordable, it is important that you perform due diligence and work out all of your income and expenditure to determine how much disposable income is left each month and of that, what proportion you are willing to dedicate to loan repayments. Remember to save a proportion of your “spare” money to fund emergency repairs or other unexpected costs.

When considering taking out a substantial loan, you should consider how you would repay it should your financial situation change and if you have any doubts then it may be worthwhile considering an insurance policy to protect you. If you decide to do this, you will need to ensure that the cost of this policy is included in your budget.

What Are The Alternatives To A Secured Loan?

If you are looking to take out a secured loan to consolidate existing borrowing, a debt advisor will be able to support you with alternative solutions such as a debt management plan, individual voluntary arrangement, debt relief order, bankruptcy, equity release, and more. This will be based on your personal individual circumstances, fully confidential and at no cost to you. They will be able to help you with understanding the implications of any decision that you make and help you to manage your finances going forward.

If, however, you are looking to borrow money to undertake home improvements or to fund a large expense such as a wedding, then other options are:

1. Remortgaging. If you are approaching the end of your current mortgage deal or won’t have to pay an early repayment charge then it can be cheaper to remortgage than take out a secured loan.

2. Unsecured personal loan. Some lenders offer personal loans up to a value of £25,000 to individuals with a good credit rating. The loan will likely cost less overall as you will repay it over a shorter time-frame and of course, there is no need to offer your home as collateral.

3. 0% credit card. There are different types of credit cards available with several months up to a year’s interest-free credit. They tend to be for purchases, money transfer, or balance transfer. The key differences are that a purchasing card allows you to spread the cost of your spending over several months without incurring any interest, so although you pay off a lump sum in several instalments, the overall amount to pay remains the same. With a money transfer card, you can use the funds from the credit card to pay off existing debts or top up your bank balance but again, you will need to repay the amount in full before the end of the 0% interest period. A balance transfer card allows you to consolidate debts from a variety of other cards more cheaply provided that you pay off as much as you can (preferably all of it) before the end of the interest-free period. Some of these cards may have transfer fees and to make best use of these cards, always ensure that you pay off the balance before the interest-free period ends, otherwise you are likely to be landed with a far higher interest rate which will negate the benefit of switching.

Are There Any Other Risks To Consider?

It is worth noting that secured loans [7] are not covered by the Consumer Credit Act 1974 meaning that once you have signed the legal charge and returned it to the lender you don’t have any right to withdraw. Depending on the terms and conditions of the loan that you have taken out, you may be able to repay the loan early, but this is likely to incur interest and an early repayment fee which could be up to 5% of the amount you owe.

In Summary

Secured loans are a way of borrowing a large amount of money over a long period of time with affordable monthly payments but always remember that your home is at risk should you fail to pay, and in order to protect or even improve your credit score, it is important that you manage your loan responsibly.