Second charge loans – a possible solution to the puzzle
Many mortgage intermediaries are reluctant to get involved with secured loans. But the market is changing because they are beginning to realise that there are many occasions when a secured loan provides a superior funding solution to a remortgage. To assess the most advantageous solution, the total cost of borrowing is calculated for both options.
The obvious instance is where a borrower has a large redemption penalty on their existing loan and they wish to raise extra finance. Every case needs to be considered on its merits, but Table 1 shows a typical example where a secured loan is the best option.
In this case, if the borrower remortgages, they add the early redemption charge (ERC) to the loan along with the extra finance required. Overall, therefore, there is a loss of equity of £20,500. They not only have to pay the redemption penalty but also lose out on the low interest rate that the original mortgage provides. If they arrange a secured loan, they do not need to pay the early redemption charge and the secured loan is arranged on a capital repayment basis. Therefore, after five years, the borrower is over £11,000 better off by choosing the secured loan option. With the responsibility to provide best advice, intermediaries should at least do these sums before advising the borrower on the best option. Incidentally, while the commission that an intermediary can earn should not be a deciding factor, the commission from the secured loan and the procuration fee from the remortgage are likely to be of broadly similar value, depending on the lenders chosen.
Mending the part that’s broken
Sometimes a borrower who has a prime mortgage that has been well maintained, but has acquired poor credit elsewhere, needs to raise additional finance. One option is to remortgage, but by doing that the borrower will be charged an adverse interest rate on the entire loan, rather than merely on the additional finance. A secured loan can often provide the best solution. Table 2 shows an example of this.
Here, the borrower is being charged an adverse rate on the total loan if he remortgages. By using a secured loan, the borrower can still enjoy the prime rate on most of their borrowing and is only charged a higher non-conforming rate on the new secured loan. The overall financial benefit after five years is nearly £13,000, with the secured loan completely cleared after five years.
If one of your clients has a large redemption penalty and they have recently gained some adverse credit history, then the secured loan route is almost always the best solution. Table 3 shows an example combining these two factors.
In this example we have a very large difference in both the total monthly loan payments and the final loan amount which results in a total saving in excess of £30,000 after five years if the secured loan route is chosen.
Secured loans plus points
While the overall cost of borrowing is a major consideration, other factors should also be considered. Speed is one of the most overlooked aspects of the remortgage versus secured loan comparison, and is a factor which tends to be forgotten. However, it is just as valid in a compliance context as overall cost.
Typically secured loans can complete in under 21 days, some in as little as 10 days. When a client needs to obtain additional finance quickly, then the usual concerns that govern suitability need to be tempered by the time frame in which the client needs their funds. Provided they are aware of the facts, then if speed is the primary issue, a secured loan will win every time over remortgage or further advance.
Fees charged by mortgage lenders are another area that needs to be taken into account when assessing the right choice. Mortgage brokers are aware of the costs of mortgages including valuation and administration fees, higher lending charges and conveyancing fees. Secured loans carry none of these charges. This can make a real difference to the cost equation and is another reason why brokers should add up the peripheral costs as well as look at the headline rate.
Mortgage criteria can also be restrictive. Apart from the obvious one, where a client’s credit profile has deteriorated since taking out his first mortgage, the facts are that loan criteria, particularly in the area of loan-to-value, can be more accommodating. Loan rates can lack the sophistication of fixes, caps and discounts, which their first mortgage cousin possesses, but rates are keen and easily understandable as an APR. With some secured loan lenders, including Swift, criteria will also allow DSS and pension benefits as part of a client’s income, something that mortgage lenders are not noted for.
It is also worth remembering that early redemption penalties on regulated secured loans of up to £25,000 now carry a maximum of only one months interest. The secured loan market has been quietly adapting to the current changing environment and it can now look the world squarely in the eye with a completely transparent charging structure.
It’s not black and white
Every case must be viewed on its merits. But it’s always worth doing the numbers to see which solution provides the best financials for the client. While there are still many borrowers with significant early repayment charges attached to their mortgages and existing borrowers continue to suffer credit problems, we expect to see more and more mortgage intermediaries needing to become involved with secured loan business.
John Webster is chief executive officer of the Swift Group