In this brief guide, we will discuss secured loans( interest-only). interest-only secured loans may be useful for a lot of purposes especially when there is huge capital expected at the end of the secured loan term through an asset sale or other means.
With this in mind, interest-only secured loans have become more popular even as their counterparts the interest-only mortgage goes somewhat out of fashion.
Interest-only secured loans are also known as interest-only second charge mortgages due to the fact that many people inquire about them as an alternative to getting a further advance or taking out a second mortgage.
In principle, a second mortgage and an interest-only secured loan work on similar frameworks. For one, they are both secured on the property.
What is an interest-only secured loan?
An interest-only secured loan is a loan where the capital is repaid at the end of the loan term and instead a monthly repayment is made on the loan based on the interest being applied to the outstanding secured loan balance.
The capital borrowed on an interest-only secured loan is usually repaid with a separate repayment vehicle in the same way an interest-only mortgage will usually be repaid in full at the term with a separate repayment vehicle. Due to not having to repay any of the capital during the loan term the monthly repayments on an interest-only secured loan are usually much lower.
Why you may need an interest-only secured loan?
There are various reasons why someone may decide to get an interest-only secured loan. This could include:
To consolidate debt
For home improvements and renovations
What is the difference between secured and unsecured loans?
The main difference between secured an dunsecuredloans is the fact that a secured loan has an asset secured on the loan such as a mortgage whilst an unsecured loan will not have an asset secured in the loan such as credit cards.
What are secured loans?
Secured loans are loans which are secured on an asset(also known as collateral). This can either be a car, a house or other assets such as jewelry. Secured loans will usually be much cheaper than unsecured loans due to the fact that the lender has an asset(also known as collateral) which they can repossess if the borrower fails to repay the secured loan. The fact that a lender will have an asset to repossess usually makes secured loans much easier to get.
The good thing about a secured loan is that it protects the lenders interest and it allows you to have a cheaper lending product in comparison to an unsecured loan.
The downside of a secured loan is that if you fail to make your monthly repayments, the lender will repossess your collateral and sell it in order to recoup any balance on the loan.
What are unsecured loans?
Unsecured loans are loans which are not secured on an asset(also known as collateral)such as a boat, house car or even jewelry. With an unsecured loan the lender will not have any assets to repossess.
This usually makes unsecured loans much more expensive and much harder to get. The fact that there is no asset secured on the loan does not mean that you may still not lose your assets if you default on the loan. The lender may still be able to repossess your assets through a county court judgement.
The reason why unsecured loans are usually more expensive is that the lender carries a much higher risk of not being able to recoup their funds and will usually have to incur some costs to recoup their funds with no guarantee that there will be any assets to seize or funds to be recouped.
Pros and Cons of interest-only secured loans
There are various pros and cons of interest-only secured loans, below we have listed the various pros and cons of interest-only secured loans.
Pros of interest-only secured loans
One of the main pros of interest-only secured loans is that they tend to be cheaper than unsecured loans as the lender has less risk due to the collateral which is secured on the loan.
Peer to peer loans have also made secured loans much cheaper by cutting out the lender and providing a service where people who have funds to lend provide them to people who are looking for funds to borrow.
Lower monthly repayments
Due to the fact that you will only have to pay the interest portion of the loan with your monthly repayments the payments on an interest-only secured loan will usually be much cheaper than a standard secured loan. You will then have to pay the full capital borrowed at the end of the loan term with a separate repayment vehicle which the lender may hae approved before approving you for the loan
Easier to get approved for
interest-only secured loans are much easier to get approved for as they are secured loans which carry collateral and thereby reduce the risk for the lender. However, you should note that when comparing interest-only secured loans to normal secured loans you may find that the interest-only version is much harder to get approved for due to the risk of default at the end of the term where the capital borrowed is due to be repaid in full.
Helps build your credit score
With an interest-only secured loan, you will be able to build your credit score and this could help improve your affordability for other credit products.
Your credit score will improve as you make on-time credit repayments on your loan.
Flexible repayment terms
An interest-only secured loan may be able to offer you much longer repayment terms unlike unsecured loans which will usually offer repayment terms of between 3 and 7 years. With a secured loan you may be able to get repayment terms of as much of 15 year. Some lenders will even allow you to extend the term of your loan if you are struggling to find a capital repayment vehicle.
Before extending the term of your loan you should ensure you are able to continue making repayments on them and you should search the market to see if you may be able to get a better loan product on the terms you want in comparison to extending your loan term for your current loan.
You should use an interest-only loan calculator to see how much you could potentially borrow and what your monthly loan repayment could be
Cons of interest-only secured loans
Collateral could be repossessed
One of the main cons of an interest-only secured loan is a risk of repossession if you fail to make the capital repayment which is due at the end of the loan term.
Difficult to get
interest-only secured loans may be much harder to get due to their interest-only repayment element. Most lenders may prefer a capital repayment loan where your monthly loan repayments include both the capital and interest element.
Getting an interest-only secured loan with bad credit
Getting an interest-only secured loan with bad credit may be much harder as most lenders prefer to lend to borrowers who have good credit. An interest-only loan has a huge capital repayment requirement at the end of the loan term and this makes them much higher risk than a conventional secured loan.
There are however mortgage lenders who will offer an interest-only secured loan to a borrower depending on what type of bad credit was and what the circumstances were.
If it was a CCJ which was satisfied and is a certain age then some mortgage lenders may be willing to lend. Other mortgage lenders may lend if the CCJ was a maximum amount.
When looking to get a secured loan with bad credit the requirements from different mortgage lenders will differ and a bad credit mortgage broker may be able to assist you in getting a secured loan.
Bad credit could include:
A debt management plan
A home repossession
If you are unsure of what your credit score is then you should check your credit score from the four credit bureaus in the UK: Experian, Crediva, Equifax and Transunion.
Some of these credit bureaus may charge you a fee to view your credit report so what you can alternatively do is request a statutory credit report which is a free credit report which each credit bureau must provide to you upon you requesting it.
Alternatively you can also use credit score services such as Checkmyfile and clearscore to check your credit report.
Once you have done this you should then check on a credit card eligibility platform to see what secured loans you are eligible for and then apply for the best one. Alternatively you may want to use a mortgage broker.
How much can you borrow on a secured loan?
The amount you can borrow on a secured loan will depend heavily on your credit score, any equity you have in your property and the lending criteria of each lender especially in regards to the loan to values they will be willing to offer on both an interest-only secured loan and a capital repayment secured loan.
Some of the key lending requirements of secured loan lenders are listed below:
Loan to value rates
Different secured loan lenders will have different loan to value rate requirements based on their internal lending score cards but mostly based around the level of risk they are willing to accept. Some lenders will have maximum loan to value rates of 85% but this can go all the way down to 65% based on the lender.
When considering the loan to value you can get with a secured loan, you should remember that the lender will be taking into account your current mortgage balance as well as the additional borrowing you are after except the lender agrees to be a second charge lender.
In the first instance this means the secured loan lender will be paying off your current mortgage as well as providing you with a further advance as part of your loan.
In the case of a lender who has a maximum loan to value of 80%- this means they will only lend you up to 80% of the value of your home and you have a home which is worth £500,000 with an outstanding mortgage balance of £100,000 the maximum loan you will be able to get will be 80% of 500,000 minus your current mortgage balance. This is £300,000.
Different lenders will have differing requirements on what the minimum equity they will be willing to accept is. If you have very little equity in your property and you are concerned about this then you should check with your mortgage broker.
You can of course increase the equity in your property or the equity you have towards the secured loan by putting a deposit down.
Income and mortgage affordability requirements
Different mortgage lenders will have different income and mortgage affordability requirements.
Mortgage lenders will accept a variety of income sources such as:
Full time employed jobs
Self employed income
Lenders will however each have their own ways of assessing your ability to repay the secured loan and in some cases they may not consider all of your income which may affect your mortgage affordability.
In the case where the lender accepts maintenance payments they may only accept payments which are ordered by the courts.
Lenders will also look at your expenditure to determine if you can afford the monthly repayments on your interest-only secured loan.
Should you just get a remortgage?
Whilst considering if to get a secured loan on your property you may have considered remortgaging but to work out which option is best for you you have to adequately compare both options.
There are situations where remortgaging may not be a better option, we explore some of those below.
Remortgaging may not be a good option for you if your mortgage affordability has fallen and you are no longer able to qualify for a mortgage with a suitable APR. This could be because your credit score has fallen due to bad credit behaviour such as missed credit repayments etc.
Remortgaging may also not be a better option than a secured loan if you want a different repayment option other than a capital repayment.
Another main reason why a remortgage may not be a better option could be because the early repayment fees involved with closing your current mortgage may make the process much more expensive. Comparing the costs of remortgaging and the costs of getting an interest-only secured mortgage as well as the costs of both options will allow you to see what option is the best one for you.
Another reason why remortgaging may not be a much better option is because you may already be on a much better rate and will prefer to keep your current mortgage whilst you get an advance from an interest-only secured loan.
What happens at the end of your interest-only secured loan?
At the end of your interest-only secured loan, you will have to pay the capital which was originally borrowed as the monthly repayments on your interest-only secured loan only contain the interest charge on your capital balance and no repayments on the capital borrowed.
Before you got approved for your interest-only secured loan the lender will have asked you for a suitable repayment vehicle and will have then approved your capital repayment vehicle as well as performed ongoing monitoring or taken regular checks throughout your mortgage term to ensure that your repayment vehicle is still in place and performing well.
Some of the most common repayment vehicles which most lenders will usually accept include:
Sale of the property
Sale of another property
Investments such as stocks and shares
Sale of a business
Open-ended investment companies
There are some scenarios where you may not have enough in your repayment vehicle in order for you to repay the interest-only secured loan in full. In this case, you may be able to do a few things after speaking to your lender.
This could include:
Remortgaging the loan with the lender to a cheaper rate and extending the loan term could be one option.
Another option could be selling your property in order for you to repay the capital borrowed.
You could also repay the interest-only secured loan by taking out an equity release product on your residential home.
You could also repay the interest-only secured loan by using cash.
You could also potentially remortgage the interest-only secured loan to a capital repayment loan.
In some cases remortgaging may be difficult due to your age, in this case, you can seek out an equity release provider or a mortgage lender who offers remortgages to borrowers at an older age or with a much higher age restriction. You may also be able to find mortgage lenders who will offer remortgages with no age restrictions for borrowers.
If you are unable to repay the capital initially borrowed at the end of your loan term then the lender may indeed be within their rights to repossess your property.
FAQs about interest-only secured loans
Some of the most frequently asked questions about this topic include:
Can you get interest-only loans?
Yes, you can get interest-only loans as these are now more readily available on the market.
With an interest-only loan, you will simply have to repay the capital borrowed at the end of the loan term.
Are secured loans easier to get?
Secured loans may be viewed as easier to get due to the fact that the lender will have an asset secured on the loan which they can repossess if need be.If you have bad credit then you may find that secured loans are a better option for you due to the collateral you have placed on the loan.
What happens if you Cannot pay unsecured loans?
If you cannot pay an unsecured loan the debt will usually be sold to a debt collector but in some cases the lender may issue a county court judgement against you in order to compel you to pay the debt. You may eventually end up having your property repossessed if you do not repay the unsecured loan.
Are secured loans a good idea?
Secured loans could be a good idea but they could also be a bad idea. It all depends on your personal circumstances and what you need a secured loan for. You should contact your mortgage broker and discuss this with them.
How to get an interest-only secured loan
You may want to consider using an independent mortgage broker to get an interest-only secured loan.
Mortgage brokers are important as they can access mortgage products from across the whole of the market in some cases. There will be mortgage lenders which provide secured interest-only loans and your mortgage broker may be able to assess these products to see if you are eligible for them. This could be over 11,000 mortgage products. This may have some advantages than going directly to a mortgage lender.
A mortgage broker will look to understand your financial circumstances and then provide recommendations on which mortgage products may be suitable for you.
After giving you these mortgage recommendations, most mortgage brokers will seek your consent to apply for a mortgage in principle. This will allow you to shop for your home easier as more estate agents and sellers may take you seriously or it will give you confidence that your remortgage is indeed a possibility before you make a full mortgage application. Once you have found a home you want to buy or are satisfied with the mortgage offer for your remortgage then the mortgage broker will then look to get you a mortgage offer.
This will come with a key facts illustration document which details out the features of your mortgage including how much you will pay per month if there are any limits such as early repayment fees, or annual overpayment limits.
If you are happy with everything you can then go on to secure your mortgage with the help of a conveyancer. Your conveyancer will manage the legal searches on the property to ensure there aren’t any issues with it, they will oversee the sales agreement to ensure it is in your best interest, they will manage the transfer of mortgage funds, exchange contracts with the seller or their conveyancer and set a completion date with the seller or their conveyancer.
In this brief guide, we discussed interest-only secured loans. If you have any questions or comments please let us know below.
If you need financial advice and you live in the UK then you could contact the Money Advice service over the phone or via chat for impartial advice.
You can also contact the debt charity “Step Change” if you are in debt and need help.