Second Charge Mortgage and how does it work?

Purchasing a home is one of the most significant financial decisions many people make. Over time, homeowners may find themselves needing additional funds for various reasons, such as home improvements, debt consolidation or investing in other opportunities. One way to access these funds is through a second charge mortgage.

What is a Second Charge Mortgage?

A second charge mortgage is a type of loan that is secured against a property that already has a first charge mortgage. It is called a “second charge” mortgage because the second charge lender’s claim on the property ranks behind the first charge mortgage lender’s claim. If you default on your payments and the property is sold to repay the debts, the first charge mortgage lender gets paid before the second charge lender.

How Does a Second Charge Mortgage Work?

When you take out a second charge mortgage, you are essentially borrowing against the equity that you have built up in your property. The equity is the difference between the market value of your property and the outstanding balance of your first charge mortgage. For example, if your home is worth £300,000 and you have £150,000 left to pay on your first charge mortgage, you have £150,000 in equity. Second charge mortgage lenders typically allow you to borrow a percentage of this equity, depending on your financial situation and their lending criteria.

To obtain a second charge mortgage, you must go through a similar application process as you did with your first charge mortgage. As well as evaluating your property, the second charge mortgage lender will assess your income, credit report and overall financial situation to determine your eligibility and the amount that you can borrow. Interest rates on second charge mortgages are usually higher than those on first charge mortgages due to the increased risk for the second charge lender.  

Benefits of Second Charge Mortgages

Access to substantial funds is one of the main benefits of a second charge mortgage. This can be particularly useful if you need money for significant expenses, such as home renovations, paying off high interest debts or investing in a new property. Additionally, if you have a favourable interest rate on your first mortgage, a second charge mortgage allows you to keep that mortgage while still accessing additional funds. This could be advantageous compared to remortgaging if that would result in a higher overall interest rate or trigger early repayment charges.

While second charge mortgages are typically provided at higher interest rates than first charge mortgages, these are still often lower than rates on unsecured personal loans or credit cards. This is because the second charge mortgage is secured against your property, reducing the lender’s risk.

Risks and Considerations

Taking out a second charge mortgage increases your overall outgoings. If you were to experience a change in circumstances, such as job loss or illness, you might struggle to keep up with the additional payments. Since a second charge mortgage is secured against your property, failure to keep up with the payments can result in the second charge lender starting repossession proceedings. It is, therefore, important to consider your ability to manage the additional debt carefully before proceeding with a second charge mortgage. Typically, your first charge mortgage lender will also need to agree to a second charge being entered against your property.  

The Application Process

The first step in applying for a second charge mortgage is a thorough assessment of your financial situation. Lenders will evaluate your income and expenditure, existing debts, credit report and overall financial situation, and the amount of equity remaining in your property. Research different lenders to find one that offers favourable terms for second charge mortgages. Consider factors such as loan-to-value limits, interest rates, fees and customer reviews. Once you have chosen a lender, you will need to complete an application form and provide supporting documentation. The latter typically includes proof of identity and income and expenditure, and details of your existing mortgage and other debts.

The lender will require a valuation of your property to determine its current market value and the amount of equity available. If your application is approved, the lender will send you an offer letter outlining the terms of the second mortgage. You will need to review these carefully and work with a solicitor to complete the legal process. The solicitor will ensure that all the required legal documents are in order and that the second charge is registered with the Land Registry. Once the legal process is complete, the funds from the second charge mortgage will be released to you. You can then use the money for your intended purpose.

Key Differences Between Second Charge Mortgages and Second Mortgages

While both second charge mortgages and second mortgages involve borrowing additional funds, they are quite different transactions. A second charge mortgage is typically used to release equity from an existing property with a first charge mortgage for purposes such as home improvement, debt consolidation or investment. By contrast, a second mortgage refers to taking out a first charge mortgage on a second property, such as a second home, holiday home or buy to let property.

A second charge mortgage is effectively secured against the equity remaining in a property that already has a mortgage with a first charge. On the other hand, a second mortgage is secured as a primary mortgage with a first charge against an unmortgaged second property.  

In terms of risk and priority, a second charge mortgage lender is paid after the first charge lender in case of a payment default and property sale, whereas the lender of a second mortgage with a first charge has the first priority.  

Generally, second charge mortgages incur higher interest rates and fees compared to first charge mortgages, but these can still be lower than unsecured loans. The rates and terms for a second mortgage depend on the specific mortgage product, property being financed and the borrower’s financial circumstances.

When to Consider a Second Charge Mortgage?

If you want to renovate or extend your existing property, a second charge mortgage can provide the necessary funds without altering your current first charge mortgage terms. Consolidating high interest debts into a single lower interest loan can also reduce your monthly payments and make managing your finances easier. Financing significant expenses, such as a wedding, educational costs or medical bills, can also be more affordable with a second charge mortgage compared to unsecured loans. If you are looking to invest in a new property or need capital for a business venture, again, a second charge mortgage can also potentially provide the required funds.

Alternatives to Second Charge Mortgages

Refinancing your existing mortgage to access equity can sometimes be more cost effective than taking out a second charge mortgage. Unsecured personal loans can be a viable alternative if you need a small amount of money and prefer not to use your property as collateral. For short-term or smaller expenses, credit cards can potentially offer the flexibility you need. However, these alternatives typically come with higher interest rates compared to secured loans. For older homeowners, equity release products such as lifetime mortgages can provide access to funds without requiring monthly payments. These are typically repaid when the property is sold, either after the homeowner moves into long term care or passes away.

Conclusion

A second charge mortgage can be an effective way of accessing substantial funds by effectively leveraging the equity in your existing property where you already have a primary mortgage with a first charge. It offers flexibility in how you use the funds and allows you to maintain the favourable terms on your first mortgage. However, it also comes with risks, including higher interest rates, an increased financial burden and the potential for repossession if you fail to keep up with the necessary payments. It is crucial to assess your financial situation thoroughly before proceeding with a second charge mortgage. Consider the alternatives and, ideally, consult a financial advisor or mortgage broker.

FAQs

Q. What is a second charge mortgage and how does it differ from a remortgage?

A. A second charge mortgage is a second loan secured against your property in addition to the primary mortgage on your property with the first charge. Unlike remortgaging, which replaces your existing mortgage, a second charge mortgage allows you to keep your original primary mortgage while borrowing additional funds.

Q. What are the eligibility criteria for a second charge mortgage?

A. Lenders typically assess your equity in the property, and your credit report, income and expenditure, and overall financial situation. A significant amount of equity and a good credit and financial standing improve your chances of approval.

Q. What are the benefits of taking out a second charge mortgage?

A. Benefits include access to substantial funds without altering your first charge mortgage and potentially lower interest rates compared to unsecured loans.

Q. What risks are associated with second charge mortgages?

A. Risks include higher interest rates compared to first charge mortgages, an increased financial burden and the potential for repossession if the necessary mortgage payments are not maintained.

Q. How do I apply for a second charge mortgage?

A. The application process involves assessing your financial situation, choosing a suitable lender, submitting an application with the necessary supporting documentation, property valuation, obtaining an offer and completing the legal procedures with the help of a solicitor or conveyancer.

References:

Second Mortgages | Money Helper