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Interest only secured loan

Everything you wanted to know about interest only secured loans

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By Pete Mugleston  | Mortgage Advisor Pete has been a mortgage advisor for over 10 years, and is regularly cited in both trade and national press.

Updated: 23rd August 2019 *

Interest only secured loans (also known as interest only second charge mortgages) is a topic we get tonnes of enquiries about, whether it’s for general information, assistance after an application was declined or help with a new application.

By the way, if you’re looking for info on second mortgages (as in, another mortgage for a second property), then go to our article on second property mortgages

Once you’ve read through the details below, you can make an enquiry with us to be connected with an expert who can speak with you directly about your own situation.

In this article we will cover the following:

Difference between unsecured and secured loans

Secured loan

A secured loan is a debt where the lender uses some form of tangible asset, such as a property or vehicle, as collateral in order to ensure have a way of repaying the debt if the borrower defaults, by repossessing the property and selling it.

So, for interest only secured loans the lender would use your existing property as security for that loan. If you miss payments or default on the loan the lender can repossess the property and use any value left when they sell it, to reclaim the money they are owed.

The secured aspect of the loan is really for the benefit of the lender rather than the borrower. Only if you already own a property can you apply for an interest only secured loan in the UK.

If you already have an existing mortgage on a property but want to raise further funds for a specific requirement (see section on this below) this might be a viable option. In effect you would have two mortgages secured against your property, which is why these loans are sometimes referred to as interest only second mortgages.

Unsecured loan

An unsecured loan is where the lender does not seek to hold any asset as security as part of the loan agreement. Typical examples of unsecured loans would be a personal loan, a credit card or bank overdraft.

Unsecured loans tend to have much stricter lending criteria and higher rates (but not always) than a secured loan, as the lender carries higher risk of not getting their money back

Advantages and disadvantages of an interest only secured loan

Lower repayments

As with your main mortgage, there are two repayment methods available to you for second charge mortgages – capital and interest (more commonly known as repayment) or interest only.

Repayment mortgages collect a proportion of both capital and interest each month across the term. With an interest only secured loan you make a monthly interest payment leaving the whole capital amount to be repaid, via a separate repayment vehicle, in full at the end of the term.

This means your monthly payments with an interest only secured loan will be lower as a result. If you get in touch we can make sure an expert provides you with more details in this area and connects you with the right lender if you choose to proceed.

Lower interest rates than unsecured loans

As an interest only secured loan would be secured against your property lenders are typically more willing to offer a lower interest rate than with an unsecured loan. Lower interest only second mortgage rates will help keep your monthly payments down leaving you with more spare income to commit elsewhere.

Flexible/longer payment terms

Typically, unsecured loans are only be available up to a maximum of seven years, however, an interest only secured personal loan using your property as collateral can allow for much longer terms.

Most lenders would consider terms of up to 15 years, some would stretch to 20 years and a few lenders allow up to 25 years and more. However, be mindful that a longer term whilst offering lower payments can also result in the total amount repayable being much higher overall.

Build your credit history

Secured loans by their very nature offer a lower risk to a lender as they have access to your property in the event of a default. As a result, lenders some are much more willing to accept applications for an interest only secured loan than for an unsecured loan.

This can be a very useful form of lending if you’ve had difficulties borrowing money in the past due to issues with your credit rating. An interest only secured loan, as they’re sometimes easier to attain, will allow you to rebuild your credit rating for any borrowing requirements you may need in the future.

Capital must be repaid

Whether as a second or first charge mortgage, with an interest only repayment method you must also ensure you have an acceptable repayment vehicle to cater for the capital payment due at the end of the term.

The repayment vehicles which can be used are discussed in more detail elsewhere in this article. If your repayment vehicle is not monitored during the term and there is a shortfall at the end you will need to take further action, either using additional funds elsewhere or consider remortgaging.

Most, if not all, options available involve further costs to the borrower. If, as in some cases, the capital cannot be repaid in full and no other options are viable the lender is entitled to commence repossession proceedings. To find out more about the points raised above make an enquiry and an expert can get in touch to give you the right advice .

Why would you apply for an interest only secured loan?

Historically, the main reason someone would look at an interest only secured loan would be for home renovations. That new kitchen or extension you’ve been craving but have never able to build up the spare cash for. Rather than wait, you can use the equity in your property to raise the money with a second mortgage on an interest only basis.

One of the other most common reasons is to consolidate debts such as loans and credit cards, into one simple monthly payment, usually on lower interest and over a longer term - this allows cheaper monthly payments and can be essential to many whose spending has gotten out of control.

There are host of other valid reasons why you would consider raising funds this way. A holiday of a lifetime to celebrate a significant anniversary or a buy to let opportunity that’s too good to turn down.

Make sure you can afford the repayments

As with all lending, you need to give careful consideration of your monthly budget and ability to maintain the loan repayments throughout the term. Particular caution should be taken with debt consolidation as moving to an interest only secured loan may not be the most cost effective in the long run.

The tables below illustrate the dilemma many borrowers have when considering whether to continue paying a shorter term unsecured loan or switch to a longer term secured loan:

Personal loan, borrowing £15,000 at an interest rate of 5%

Term Monthly payment Total Amount Repayable
3 years £448.32 £16,157.32
5 years £282.31 £16,938.36
7 years £211.23 £17,743.05

Interest only secured loan, borrowing £15,000 at an interest rate of 3%

Term Monthly Payment Total Amount Repayable
10 years £36.99 £19,439.29
15 Years £36.99 £21,658.93
25 years £36.99 £26,098.21

As you can see, the longer-term option does look very attractive from a monthly payment perspective. However, despite a lower interest rate the total amount repayable is quite a lot higher than the personal loan.

How much can you borrow?

The amount you can borrow will vary from lender to lender and is based on two key factors; the equity in your property and the loan to value policy of each lender.

Minimum equity requirement

Most lenders will have a minimum equity requirement. For example, if a particular lender has a minimum equity requirement of £200,000 and you already have a first mortgage with a balance of £100,000 the most you would be able to borrow for a second mortgage would be £100,000.

Most lenders have a minimum equity requirement of £150,000, some £100,000 and a few have no minimum equity requirement at all.

Loan to Value

In addition to the minimum equity requirements, lenders will also have their own loan to value criteria (LTV) for all interest only secured loans. For example, if a lender has an LTV maximum of 60% and your property is worth £200,000 with a balance of £70,000 owing from your first mortgage, the maximum further borrowing you could have would be £50,000.

Most lenders have a maximum LTV for interest only mortgages of at least 50%, some allow 75% and a few go as high as 85%. If you make an enquiry we can ask an adviser to speak directly with you and offer more guidance in this area.

Interest only second mortgage or a remortgage?

Rather than take out a second mortgage on your existing property in order to raise fresh funds you might be thinking “Why not just remortgage?”. This is a fair question and it’s worth exploring the remortgage route, however, there are a few situations where it might be in your best interest to pursue a second charge mortgage.

If you are already tied for a specific period to a favourable fixed or tracker rate on your first mortgage does it make financial sense to break this, also incurring early penalty fees, in order to remortgage or is a second mortgage more viable? A comparison of the fees payable to break the terms of your first mortgage versus the fees that apply to a second mortgage would be a worthwhile exercise.

You may have an amazing deal and not want to refinance away.

You may not be able to refinance your main mortgage due to affordability or credit history, but a secured loan lender might consider you (as they can be more flexible).

Your first mortgage may be a traditional repayment mortgage and you might want a different repayment strategy for any further lending, therefore, an interest only secured loan for your second mortgage may well be a more attractive route. It’s important to explore all the options available before reaching a decision. If you get in touch a specialist will be able to assist you further.

Income and affordability criteria

All lenders have their own criteria for assessing an applicant’s ability to repay mortgage debt. As mentioned above, the criteria for interest only secured loans is usually pretty flexible and lenders can be more generous when looking at affordability and previous credit issues.

Below is a general list of what lenders would deem as acceptable income streams:

  • Fixed salary full-time employment income
  • Varied/commission based full-time employment income
  • Part-time employment income
  • Self-employed income (net profit / dividends)
  • Pension income
  • Temporary/freelance contract work (value of contract / daily rate)
  • Investment income (rent / trust monies)
  • Maintenance payments
  • Certain government benefit payments

Most lenders will accept maintenance payments as acceptable if awarded through the courts, some will also accept out of court agreements. Once income is established, lenders will assess any major outgoings that could impact on the borrower’s ability to make the payments for any new lending.

What happens when you reach the end of the term of an interest only secured loan?

Once you’ve reached the end of the term of an interest only secured loan it is now time to repay the original capital amount back to the lender.

At the outset of your second charge mortgage you should have agreed an acceptable repayment vehicle with your lender. With appropriate regular monitoring throughout the term your repayment vehicle should be on track.

The following are all considered acceptable repayment vehicles with various lenders:

  • Sale of the property to repay an interest only secured loan
  • Sale of another property owned by yourself to repay an interest only secured loan
  • Endowment policies to repay an interest only secured loan (less common these days)
  • Tax-free lump sum from a pension plan to repay an interest only secured loan (equivalent to 25% of the value of the pension fund)
  • ISAs to repay an interest only secured loan
  • Stocks and shares to repay an interest only secured loan
  • Unit Trusts to repay an interest only secured loan
  • Open Ended Investment Company (OEICs) to repay an interest only secured loan
  • Investment Bond to repay an interest only secured loan
  • Government Securities to repay an interest only secured loan
  • Family inheritance or trust fund to repay an interest only secured loan

In reality, it’s possible that your investment vehicle might have a shortfall at the end of the term, therefore, you need to discuss with your lender appropriate action to take.

The following options are available to you in the event of a shortfall:

  • Remortgage with existing lender and extend the term
  • Remortgage to a lender that will allow a longer term / age
  • Remortgage and switch to repayment
  • Sell your property
  • Repay the loan with cash
  • Equity release (if over the age of 55)

Remortgaging may prove difficult if your age at the end of the proposed new term falls outside a lender’s maximum age range. However, whilst most lenders have a cut off age of 70-75, some lenders will lend up to the age of 85 and a few now have no age limits at all.

What if none of the above are an option?

If you exhaust all of these options and are still unable to repay the capital owed, you run the risk of your lender exercising their rights by using the security element of your interest only secured loan. Ultimately, this may result in your property being repossessed in order for your lender to reclaim the money it is owed.

The key here is to contact your lender immediately and look at any and all options still available to you. Repossession is very much a last resort for lenders and, in some instances, they may let payments simply continue until a solution is sought.

Interest only secured loans and bad credit

A poor credit history can cause issues with eligibility for future credit requirements with certain lenders, depending on the type of issue you’ve had and when it was registered.

The important thing is not to lose hope as there are some lenders who will look at applications from borrowers who have had credit issues in the past and a few who specialise in these types of applications.

Certain specialist lenders will consider interest only secured loans with:

  • Late payments
  • Defaults
  • CCJs
  • Mortgage arrears
  • Debt management plans
  • With IVAs
  • After a Bankruptcy
  • After a Repossession

The first thing you must do is attain an up-to-date credit report so you know exactly what is showing. Once this is done we can arrange for you to speak with an advisor we work with to progress these discussions further.

Speak to an interest only secured loans expert

For further information about interest only secured loans and be connected to a whole-of-market broker, call Online Mortgage Advisor today on 0808 189 2301 or make an enquiry here

Then sit back and let us do all the hard work in finding the broker with the right expertise for your circumstances. - We don’t change a fee and there’s no obligation or marks on your credit rating.

Updated: 23rd August 2019
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FCA disclaimer

*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.