Interest-only mortgages, secured against an asset can be a useful financial solution for a number of circumstances in order to keep the monthly repayments down, however, as with many financial decisions, there is a range of factors to consider.
This article will explore the differences between secured and unsecured loans, the advantages and disadvantages of interest only secured loans, typically how much can be borrowed, the lending criteria and the application process.
What are the Differences between Secured and Unsecured Loans?
Secured Loans
A secured loan is a type of borrowing that, during the application process details of an asset are provided as security to the lender such as property, equipment or land.
The asset acts as collateral for the lender and in turn reduces the risks involved, that in the event of the borrower defaulting on the agreement, the lender could repossess the asset.
Secured loans often have more favourable loan terms than unsecured loans as the lender has some level of protection should the borrower’s circumstances change and can no longer make the repayments.
Unsecured Loans
Unsecured loans are where an offer to lend is solely based on the personal circumstances of an applicant and therefore the debt is not associated with an asset. Examples of unsecured loans are personal loans, credit cards or bank overdrafts.
Unsecured loans can be useful in certain circumstances however the loan values available are usually capped and therefore are not often used for big projects or purchases.
In addition, the interest rates are usually higher than secured loans, due to the risks to the lender.
Related quick help guides:
- Secured loans brokers.
- Secured loans for pensioners.
- Secured loans for self employed.
- Interest only secured loans.
Advantages and Disadvantages of Interest only Secured Loans
Now that we have distinguished between secured and unsecured types of lending, let’s focus more on the advantages and disadvantages of interest only secured loans.
Firstly, let’s clarify what an interest-only secured loan is. An interest-only secured mortgage is a financial product that enables borrowing however the mortgage holder is only required to pay the interest due to the loan each month, during an agreed term. However, at the end of the mortgage term, the capital amount borrowed remains outstanding.
Advantages of Interest-Only Secured Loans
- Lower Repayments – Interest-only mortgage repayments are cheaper than those on a standard, repayment mortgage however it is worth bearing in mind that once the mortgage term is concluded, the capital loan is still due and therefore a strategy to repay this will still be required.
- Lower interest compared with unsecured loans – Typically lower interest rates are applicable to secured loans due to the linked asset.
- Longer repayment terms – Usually secured loans offer longer repayment terms than unsecured loans that are often capped at seven years.
Disadvantages of Interest-Only Secured Loans
- Capital remains outstanding – The main downside of interest-only lending is that the capital must be repaid at the end of the mortgage term. Therefore, a repayment strategy must be in place and agreed upon with the lender before taking out the loan.
- Interest-only loans can work out expensive – As the capital is not being reduced during the term of the loan the level of interest charged will not decrease either therefore more interest is paid over the term compared with repayment mortgages.
- Riskier – As a separate exit strategy is required with interest-only mortgages, the repayment vehicle such as investments or pension funds could act in a different way to the plan therefore there may not be enough of a fund to pay off the capital when needed.
Why would you apply for an interest-only secured loan?
Typically an interest-only secured loan is attained by those looking to renovate their home. For example, upgrading an old kitchen, in which circumstance you can release some equity from your property to fund the project rather than waiting to save up enough cash.
Another popular reason for an interest-only secured loan is to consolidate debts, for example, consolidating multiple credit cards and loans into a single monthly repayment. This often allows people with considerable debts to secure a lower interest rate and lower payments over a longer-term, allowing them to regain control over their finances.
Helpful guides:
- Can I get a secured loan on a buy to let property?
- Secured business loans.
- Homeowner loans with bad credit.
How much can you borrow?
As with standard mortgages, the amount that an applicant will be offered will vary depending on the personal circumstances of the applicant, the equity available within the property and the lender’s loan to value criteria.
Minimum equity requirement
The equity within a property is the difference between the property value and the outstanding mortgage balance. Some lenders will have a minimum equity requirement as eligibility criteria for interest-only mortgages, often of £150,000 for first charge loans.
Loan to value (LTV) criteria
As well as minimum equity requirements, lenders usually have a loan to value (LTV) criteria too. For instance, if a lender has an LTV of 60% and your property is valued at £100,000 with a balance of £50,000 owed from your first mortgage, the most you can borrow would be £25,000.
The majority of mortgage lenders have a maximum LTV of around 50%, while some can go as high as 90%. Feel free to get in touch to talk to one of our advisers today, who will be able to offer you help and advice.
Can I Switch from a Standard Mortgage to an Interest Only Mortgage?
One way of obtaining an interest-only mortgage is to enquire about switching your financial product with your current lender.
Bear in mind that your lender does not have to agree to switch products and even if they do, the lender may not offer the most competitive rates or terms, however, this could be a short-term solution depending on the circumstances.
Another matter to be aware of is that switching mortgage products may mean that any early redemption penalties or other similar fees are due.
Therefore, depending on the personal circumstances of the applicant, it may be worth seeking expert assistance to explore the wider mortgage market in order to obtain the most competitive mortgage solution.
Interest Only Second Mortgage vs Remortgage?
Instead of a second mortgage, you may have considered remortgaging your property too, so what should you do?
It’s always worth investigating whether a remortgage maybe your best option, however, there are some scenarios where a second charge mortgage will make more sense.
If you currently have a fixed or tracker rate on your first mortgage, then it may not be financially advantageous to break the contract and incur penalty fees in order to pursue a remortgage deal.
To determine this, it’s a good idea to compare the fees of breaking your first mortgage contract and the fees associated with securing a second mortgage.
Regardless if you have a good mortgage deal, you may not want to refinance at this stage.
Even so, you may be unable to refinance your first mortgage due to other reasons, such as affordability issues, while a loan provider may consider you more suitable.
Another factor is if you do not wish to change your first mortgage repayment plans e.g. extending the term and may wish to take any further financing out on different repayment terms.
The reality is that there are many different things to consider. Mortgage advisors are best placed to be able to advise the most cost-effective and appropriate approach in specific circumstances and therefore if you are considering whether to obtain a second mortgage or to re-mortgage, it would be highly recommended to book a consultation with one of our expert mortgage advisers today.
Income and affordability
As with all types of finance, lenders will assess your level of income and expenditures and determine if you can afford to make the monthly repayments of a second charge mortgage.
As stated, lenders tend to be more flexible when assessing applications for a second charge mortgage.
Here are the different forms of income that are usually accepted:
- 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
What happens at the end of the interest-only second charge mortgage term?
After you have completed the payments on the interest portion of the loan and have come to the end of the term, the next stage is to repay the original capital amount.
At the point of agreeing on your original loan, you should have come to an agreed repayment method with your lender.
These are some of the most common repayment vehicles offered by lenders:
- ISAs to repay an interest only secured loan
- Lump sum (tax free) from a pension plan
- Endowment policies to repay the secured loan
- 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
- Family inheritance or trust fund to repay an interest only secured loan
Interest only secured loans and bad credit
There’s no denying that poor credit history can impact your eligibility when applying for a loan, however, it depends on when the issue occurred and the type of issue.
If you have a poor credit history you may also be interested in reading our guide on instalment loans for bad credit.
Regardless, even if you have poor credit, it may be possible to borrow money from a specialist lender that accepts applications from individuals with poor credit.
There are loan providers that do offer loans to individuals in the following scenarios:
- Late payments
- Defaults
- CCJs
- Mortgage arrears
- Debt management plans
- With IVAs
- After a Bankruptcy
- After a Repossession
If any of the above apply to you, the first thing to do is to acquire a current credit report to see exactly what it records. Once you have a copy, you can call one of our advisers who would be happy to discuss your options and help you progress in your application.
Read our complete guide on how do secured loans work?
Interest-Only Secured Loans Summary
As with any big financial decision, research and consideration of all of the factors concerned are needed, including a comparison of costs between various options.
Our specialised team of mortgage experts can provide guidance no matter what stage of the landlord journey you are at – either just starting out, or if you have plenty of rental experience however due to a change of circumstances, you require a tweak to your financial matters. Please get in touch to book a friendly, no-obligation consultation.
Give Mortgageable a call today at 01925 906 210 or contact us to speak to one of our friendly advisors.
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