Second-charge mortgages on the rise - but is remortgaging a better option?

Second-charge mortgages are becoming more popular with homeowners, but is it ever wise to secure another debt against your home?

Nearly 2,000 second-charge mortgages were granted in January, as an increasing number of homeowners looked to borrow against their properties without remortgaging, according to the Finance and Leasing Association (FLA).

But is a second-charge mortgage really a risk worth taking? Here, we explain how these loans work and offer advice on the pros and cons of further borrowing.

What is a second-charge mortgage?

A second-charge mortgage is when you take out a second loan on your home, using equity you've built up as security.

These loans are generally offered by specialist providers via mortgage brokers. Homeowners usually take them out to fund major home improvements or because a change in circumstances - such as a credit issue or becoming self-employed - prevents them from remortgaging to unlock extra cash.

While second-charge mortgages can allow you to make the most of any equity you've built up, they remain a risky option, as you'll be saddling your home with further debt.

When you apply for a second-charge mortgage, you'll have to undergo credit checks and stress-testing to satisfy the lender that you'll be able to pay back the loan. They'll also require your property to be valued in order to work out how much equity you hold based on what it's currently worth.

Second-charge mortgage market grows

New data from the FLA shows that 1,945 second-charge loans were granted in January, at a total value of £85m - that's an increase of 18% year-on-year.

But, despite this rise in popularity, second-charge loans make up a very small proportion of the overall mortgage market. Indeed, just 23,829 loans were granted in the whole of 2018.

Fiona Hoyle of the FLA says: 'The second-charge mortgage market has made an impressive start to 2019.

'As most of this market is broker-introduced, it suggests that knowledge of second charge mortgages among brokers is growing.'

• Find out more:how to choose a mortgage broker

Why do people take out second-charge mortgages?

Funding major home improvements and dealing with changes in circumstances are among the main reasons homeowners take out second-charge mortgages.

While they won't be the right option for everyone, these loans can make sense in specific circumstances, such as the following:

• You have a very low interest rate on your main mortgage and you'd need to remortgage to a more expensive rate to access extra funds.
• Your current mortgage has a very high early-repayment charge.
• Your existing lender only offers products that are more expensive than second-charge products.
• Your credit rating has dropped, meaning remortgaging might be more expensive.

Reasons to avoid a second-charge mortgage

Even if the above makes sense, second-charge mortgages are highly risky - after all, you'll be increasing the risk of losing your home if you default.

You should avoid taking out a second-charge mortgage if any of the following applies:

• You can raise funds more cheaply by remortgaging or getting a personal loan.
• You want to consolidate debts such as credit cards or smaller unsecured loans. Second-charge deals could lead you to paying more interest in the long run, and you'll be shifting an unsecured debt to a secured debt, putting your home at risk.
• You're only just managing to meet your current mortgage repayments.

What if I sell my home?

If you decide to move, the original mortgage you took out on the property will need to be settled first.

Once this is cleared, you'll need to pay back the second mortgage - and the lender has the right to pursue this legally if you fail to do so.

• Find out more:discover how you could remortgage to release equity in your home

Second-charge mortgages and LTV ratios

When you take out a traditional mortgage, the amount you're borrowing is set against the total value of the property.

So, if you're buying a home worth £200,000 and you have a £20,000 deposit, you'll be borrowing £180,000 - that's 90% loan-to-value (LTV).

Second-charge mortgages work slightly differently.

When you take out a second-charge loan, the combined debt on your existing mortgage and the second-charge mortgage can't be above the stated maximum LTV - and the best rates are only available up to a total of 65% or 70% LTV.

So if you've built up to hold half of the equity in your £200,000 home (£100,000) through a combination of the deposit you originally put down and the repayments you've made since, you'll only be able to take out a maximum of 15% of the property's value to get a second-charge mortgage at an LTV of 65%.

As ever, the equity you have in your home - and the amount you've paid off on your mortgage - has a significant effect on the rate you can achieve.

• Find out more:LTV calculator

Second-charge mortgage rates

The cost of second-charge mortgages has dropped significantly in the past year or two, meaning you can now get a product taking you up to 70% LTV at a rate of less than 4%.

Both fixed-rate (for periods of two or five years) and variable-rate (based on the lender's standard variable rate - SVR - or the base rate plus or minus a certain margin) deals are available, though the cheapest rates right now are on variable products.When taking out one of these mortgages, you may need to pay a broker fee - which can add a significant expense to the overall cost of the loan.

Second-charge mortgages tend to be offered by specialist lenders, such as Paragon Bank, United Trust Bank, Prestige and Shawbrook - and it is Paragon that currently offers market-leading rates.

The table below shows the lowest advertised rates on second-charge mortgages at different LTV levels.

_{Source: Moneyfacts, 12 March. APRC calculated by Moneyfacts and includes net loan, projected interest, representative broker fee and lender fee, based on a 14-year term.}

Advice on your mortgage options

If you're considering remortgaging to release cash from your property or taking out a second-charge mortgage, it can be helpful to take advice from a whole-of-market mortgage broker.