Second charge mortgages rise: How risky are they?

Since mortgage rates have risen, borrowers are understandably keen to hold on to their lower fixed rates for as long as possible, and avoid remortgaging to a pricier deal unless absolutely necessary.

This presents a potential problem for those looking to remortgage to access some of the equity from their home as cash – for example if they want to renovate or consolidate debts. 

As a result, lenders and brokers are reporting an increase in customers considering second charge mortgages – a second, separate loan taken out against the equity in a property. 

This way the rate on the primary mortgage stays the same, which could save a significant amount given recent rate rises. 

Accessing cash this way has plenty of drawbacks. Rates are higher than standard mortgages, and if you can’t make the repayments you could ultimately lose your home. However, some say that it makes sense in the right circumstances.  

Borrowers took out £1.71billion in second charge loans in 2022, a 45 per cent increase from 2021, according to second mortgage specialist LoanWarehouse.

Second charge loans are especially popular with those carrying out extensions and other major works on their homes – and that is on the rise. 

Data from mortgage provider Together shows one in ten (9 per cent) of homeowners are planning to invest their finances into making home renovations instead of moving.

Within this group 57 per cent are aware of second-charge loans but the majority (60 per cent) plan to use savings to cover the cost of renovations, with 8 per cent planning to take out an unsecured loan and 5 per cent choosing to remortgage to pay the costs. 

Menachem Salzer, an accountant living in Salford, took out a second charge mortgage with Together in November 2022 – borrowing £68,950 – to fund a renovation and extension project on his family home.

Now complete the renovations have added two bedrooms and a bathroom to the house, increasing its initial £380,000 value by around £70,000.

He had initially wanted to remortgage his primary loan but as it is on a fixed 1.5 per cent rate, didn’t want to risk the increase.

‘My broker suggested the idea of taking an additional charge on the property leaving the existing mortgage as it is,’ he told This is Money.

‘We were desperate to do the extension as we needed the spare rooms but as the [personal] loan would not have been secured, the interest rate would have been much higher. This was the cheapest option.’

‘The main mortgage was probably in the region of £190,000 and additional borrowing was £70,000. So yes, I am paying a higher interest rate on the extra, but I am still paying a lower fixed rate on the main mortgage, so it works out cheaper.’

Is a second charge mortgage a good way to access extra funds?

In certain circumstances where you have a mortgage on a low fixed rate, and want to remortgage to access more capital through the equity in your home, a second mortgage could be one way to do it.

‘There may be a time-sensitive situation where a standard remortgage or further advance will take too long, a criteria situation where at this point a borrower isn’t suitable for a standard mortgage, or any number of other variables that make a secured loan the only option,’ says Gary Bush, financial adviser at Mortgageshop.com.

The affordability calculation that lenders make on a second charge mortgage is often more relaxed than the primary loan allows for greater scope of borrowing, says Justin Moy at EHF Mortgages.

Others suggest because of this it can be a way to consolidate multiple debts, especially as lenders often take a slightly more relaxed view of credit history than for other types of borrowing.

What are the drawbacks of getting an additional loan on your home? 

Second charge mortgages are generally considered riskier by lenders so attract higher interest rates. Currently, Moy says, rates start from around 6 per cent, but they can go much higher. 

On mainstream mortgages, the average two-year fixed rate is currently 5.34 per cent and the average five-year fixed deal at 5.07 per cent, according to Moneyfacts.

For second charge mortgages Together is currently offering 8.65 per cent for a five-year fixed and 8.95 per cent for a two-year fixed. 

On top of your existing mortgage, the compound interest of both loans will quickly add up. 

The length of a second mortgage may also mean that compared to other borrowing, such as a personal loan, you end up paying interest for longer meaning you pay more overall.

Experts warn that having two mortgage often means paying large amounts of compound interest and paying off the debt for longer

It is also worth noting that a second mortgage relies on the equity in your home. So, while it is secured, meaning lenders are more likely to relax their lending criteria and allow those with a weaker credit history borrow, you lose equity in your house. 

And if you cannot make your payments, you are putting your home at risk as well as increasing your debt and reducing the level of equity in your home.

Taking out a second charge mortgage may also limit your options if your circumstances change. 

If you want to remortgage your first loan, move house or take out an equity release product having a second charge on your property may limit your ability to do so.

‘You may have to settle the second charge before you sell or get permission from the lender to transfer the second charge to a new property, but they may not be willing to do that,’ says Andrew Johnson, senior advice manager at the Money and Pensions Service.

Johnson adds that those who receive any type of state benefit, particularly those that are means tested, should also think carefully about taking out a loan of this type as it may impact their eligibility.

‘As a rule of thumb if you can avoid having a second charge on your property given the high interest rates then it is probably better to look at other options first,’ he says.