Last year, Brits borrowed £93 million worth of second mortgages in the space of one month alone. But why would you go down this route? And what pitfalls should you watch out for?
A second mortgage is a loan you can get in addition to your first mortgage. Like your first mortgage, it’s secured against your home. In other words, your home acts as a guarantee that you’ll pay back the loan.
Crucially, a second mortgage doesn’t replace your first one. It’s a separate debt. So, if you get one, you’ll essentially have two loans secured against the same property. But, unlike your initial mortgage, with a second mortgage the money is yours to spend how you wish.
The basics: how does a second mortgage work?
A second mortgage can last up to 30 years, depending on how much you borrow.
To qualify you must:
Be a homeowner. You don’t have to actually live in the house, as long as you’re the owner.
Pass an affordability check
The lender will check your credit history, current income and expenses (including your current mortgage payments) in order to make sure you can afford the repayments. How much you can borrow and on what terms will partly depend on this assessment.
Have equity in your home
Equity is essentially the part of your home which you own outright. In other words, it’s how much your home is currently worth, minus what’s left of your first mortgage. With a second mortgage you're borrowing against the equity you've built up in your home. You can only borrow against the equity you have, not against the full value of your house. This means the more equity you have in your house, the more you'll be able to borrow. The rest of your house's value is tied up in your mortgage, meaning it can't be used as security.
Let’s say you bought a house for £150,000. You put down £15,000 as a deposit and borrowed £135,000 to pay the rest.
Over a few years, you’ve managed to pay £10,000 off your mortgage, which lowers your debt to £125,000. In the same time, the house’s value has gone up, and it’s now worth £175,000.
This means your equity in the house is £50,000 (£175,000 less £125,000).
You’ve repaid a big chunk of your mortgage, so your outstanding balance is low
House prices in your area have gone up
You made valuable home improvements, such as a kitchen upgrade or a new bedroom
And one reason it can go down...
House prices in your area drop, which reduces your property’s market value.
Why go for a second mortgage?
A second mortgage is esentially just a loan. This means that, even though it's secured against your home, you can spend the cash as you wish. Home improvements are the most common reason why people tend to get a second mortgage. Other reasons include starting a business, paying for a wedding or buying a holiday home.
Typically, you could also fund these expenses through other means, such as remortgaging or an unsecured personal loan. If you’re only looking to borrow a small amount, a 0% balance transfer card or 0% purchase credit card may be a better option.
However, a second mortgage has three main advantages:
It can be easier to qualify
Credit is less risky for lenders when you put something up as security. This is because if worst comes to worst, they can sell off your security to make back the debt. As a result, lenders may be more inclined to lend to you when you apply for a second mortgage than they would if you applied for unsecured credit.
It can be cheaper than remortgaging
Remortgaging means paying off your current mortgage and replacing it with a new one. Sometimes, this makes sense, because it could mean lower interest and fees. Other times, it could involve paying an expensive early repayment charge. Or, if your financial circumstances have changed, you could end up being offered a higher interest rate.
If this is the case taking out a second mortgage means you only pay a higher rate on the extra amount you borrow. There’s also no early repayment fee because you’re keeping your first mortgage.
You can borrow more
Your home is probably the most valuable thing you own. So, putting it up as security means you could borrow a much larger amount than might otherwise be available to you through a personal loan. If you need money for a big expense, such as a large home renovation project, a second mortgage may be your best option.
But there are downsides, too...
It goes without saying that a second mortgage is a big step, so you should think carefully before going for it.
Your home could be at risk
Your home guarantees the debt, and the lender can force you to sell it if you have trouble meeting your repayments. If you’re just about managing with your current expenses, a second mortgage probably isn’t right for you.
It’s not usually suited for debt consolidation
Second mortgages can last for up to 30 years. So, while the interest rate could be lower than the rate on a credit card or unsecured personal loan, you could end up paying more overall, especially on smaller debts.
It could make moving house harder
When you sell your house, you usually only have one mortgage to pay off, which means you can use the rest to put down a deposit on a new home. In contrast, when you have a second mortgage, you'll have to either pay both your first and second mortgages in full, or transfer your second mortgage over to your new home.
Securing a loan against your home is a big financial decision so you may want to speak to your lender or even an independent financial advisor before taking the plunge, to help ensure it's right for you.