Secured Loans & Homeowner Loans - A Guide

A secured loan might allow you to borrow more money than an unsecured personal loan. Your monthly outgoings may be lower with a secured loan. However, you should think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.

• What is a secured loan?
• What is a consolidation loan?
• What would a secured loan cost?
• What is the security in a secured loan?
• Who regulates secured loans?
• How do I go about taking out a secured loan?
• What are the advantages of a secured loan?
• What are the disadvantages of a secured loan?
• What are the alternatives to a secured loan?

What is a secured loan?

A secured loan is any loan that requires the borrower to provide the lender with some form of security - some item of value which they get to keep if you don't pay the loan back. There are various different types of secured loan:

• The Pawn Shop - Anything from a wedding ring to a computer - take it in and the pawn shop will loan you the amount that it estimates the item to be worth. This estimation will be much lower than the actual value. The pawn shop keeps it as collateral; you get your goods back when you pay back the loan (usually within 30 days). If you haven't paid back the pawn shop within 90 days, your wedding ring goes up for sale.
• Title Loans - The loan provider takes a lien against the title of your car or other asset. This means they have loaned you money, and therefore are considered to be legal owners of the vehicle or asset. The down side is that if you don't pay the loan back in time, then the lender is able to repossess the vehicle or asset. If you don't pay them back after they've repossessed (as well as pay for the repossession fees), then they're free to sell the vehicle or asset in order to get their money.
• Secured Car Loan - This is a loan you take out for the purpose of buying a vehicle. Remember - if you take out a loan which is secured on your car, you need to pay off the loan before you can sell the car.
• Homeowner Loan - These loans are often taken out by borrowers who may have difficulty in raising other forms of finance, such as unsecured personal loans because of an "impaired" credit history (arrears, County Court Judgements etc.). The limit of the potential loan is usually based on the surplus equity in the property (i.e. the property value minus the primary mortgage) but some lenders will advance loans of 125% of equity at a higher interest rate. The equity is calculated as the value of your property minus your mortgage.

THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE OR ANY OTHER DEBT SECURED ON IT.

What is a consolidation loan?

Many people who have a variety of credit card and store card debts and unsecured loans "consolidate" them into a single secured loan, repayable over an extended period. The interest rate is usually significantly lower than the rate charged on credit card balances, but this depends on the individual borrower.

However, if you're consolidating personal loans as well, you're converting a fixed rate into variable rate debt and you're likely to be paying interest for a much longer period, and unlike a personal loan, a secured loan means you risk losing your house if you can't meet the repayments.

If you have ever watched daytime TV you may have been amazed at the number of ads for secured loans and some of these might sound very tempting.

But if you decide to apply for one of these secured loans then it's important that you look closely at the rates charged and what this may mean for the total cost of the loan, and that you fully appreciate the gamble you are taking.

Borrowing for longer does reduce the monthly repayments, but substantially increases the total interest repaid - as the sums in the table demonstrate!

How much does a secured loan cost? Find out now with Moneyextra's secured loans comparison service !

What would a secured loan cost?

Lenders charge interest on the amount you borrow. Interest is quoted as the Annual Percentage Rate (APR) . The amount you can borrow, the term available and the APR will all depend upon the equity you have in your property, the lender's view of your ability to repay the secured loan and your personal circumstances, for example any adverse credit.

Quoted APRs will sometimes be "typical" rates, and these act as a guide only as the exact rate offered will be on an individual basis. There is a meaning to the phrase typical rate - it means that at least two-thirds of the lender's loans arranged as a result of that advert are at this rate.

Unlike unsecured personal loans which have a fixed rate of interest for the term of the loan, homeowner loans usually do not have fixed rates of interest - this means the rate is often lower than the borrower might have been able to achieve with an unsecured loan. However, the interest rate may vary in future in accordance with base interest rate moves and/or at the lenders' reasonable discretion.

Unsecured loans are only available up to £25,000 - although this may change in future. Secured loans are generally available up to £75,000 (up to £100,000 from some lenders) on much longer repayment periods - 3-25 years. Personal unsecured loans usually offer repayment periods of 6 months to 7 years.

Do you need a secured loan? How much will what you want to borrow cost you every month? Moneyextra's secured loans comparison service will tell you.

What is the security in a secured loan?

The borrower's property, whether it is already mortgaged or owned outright. Loans secured against property that is already mortgaged are known as second charges, whereas loans secured against a property owned outright with no existing mortgage in place are known as first charges.

• First Charge - If more than one loan is secured on the property, the lender with the first charge has the first call on the property if the borrower defaults on the loan.
• Second Charge - If more than one loan is secured against a property, second charge lenders only get what they're owed after the lender with the first charge has been paid off.

'Your home may be repossessed if you do not keep up repayments on your mortgage' really does mean what it says!

Secured loans are only available to property owners (or mortgage holders), where the lenders can forcibly sell your house to get its money back if you can't repay. The 'secured' bit means the lenders get 'security' not you, as if there are problems, they can repossess your home.

A lender with a second charge can still force such a sale even if the mortgage, the first charge, is up to date. Secured loans aren't an easy option for those with heavy debts. Your home isn't something to gamble with.

THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.

Who regulates secured loans?

The first charge market - mortgages - is usually regulated by the Financial Services Authority.

The second charge market secured loans is usually regulated under the Consumer Credit Act 1974 (CCA) by the Office of Fair Trading (OFT). Secured loans taken as first charges by those who own their property outright also fall into this category.

However, at present the CCA only covers loans up to a value of £25,000. Loans for sums greater than £25,000 are unregulated. For regulated loans of under £25,000 the lender must provide a consideration (cooling off) period of 7 days.

The Treasury has no plans to extend the FSA's remit to the secured loans sector. However the Consumer Credit Act 2006, which received the Royal Assent on 30 March 2006 does contain provisions to remove the £25,000 financial limit and other exemptions. This would have the effect of widening the scope of regulated credit. The 1974 CCA would then regulate all consumer loans for whatever value, as long as they are not for business purposes or a first charge mortgage or certain loans arranged for people described as high net worth individuals (rich people, in other words).

The 1974 CCA regulates the credit market in two ways, by licensing traders and by setting rules and regulations. Traders must be fit to hold a consumer credit licence and those traders who are deemed unfit by the OFT, for example because they have convictions or breach consumer legislation, will either be refused a licence or have their licence revoked. A licence will normally be granted in the absence of evidence of lack of fitness.

The secured loan industry also has its own code of practice. The Finance & Leasing Association Lending Code came into effect on 1 June 2006 and may be viewed at www.lendingcode.org.uk.

How do I go about taking out a secured loan?

When taking out a secured loan you will be asked to sign a credit agreement, which should be read carefully as the terms are legally binding. You will also be required to submit a number of documents (exactly what varies from lender to lender):

• Document showing your age
• Proof of residence
• Proof of ownership of house or equity
• Proof of your income (Some lenders may ask for your bank statement)

When assessing your application for a secured homeowner loan UK lenders will consider your income and financial commitments to determine whether you can afford to take on and repay additional finance. They will look at your past credit history and take into consideration any adverse credit such as mortgage arrears, defaults or county court judgements.

All lenders insist that where an applicant is married, or in a civil partnership, both parties should be named on the application form - why? Simple - there have been cases in the past where one party took on a secured loan, defaulted but when the lender tried to force a sale of the property, the other party was able to block it by claiming to be in ignorance of the loan.

THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE OR ANY OTHER DEBT SECURED ON IT.

What are the advantages of a secured loan?

The big advantage to the borrower of a secured loan is that monthly repayments can be reduced by spreading them out over an extended period thereby easing the pressure on cash outflow. Is this really an advantage? Maybe but maybe not - we know the longer you borrow for, the more interest you will pay as was illustrated in the previous table.

In another example the borrower may have incurred credit problems since taking out a mortgage with the original mortgage lender. By raising the extra capital through a re-mortgage rather than a secured loan, such a person might lose their current rate and end up with a higher rate for all borrowings through the new lender.

Secured loans are almost always offered at cheaper rates to people who have good credit history than to those who have a poor credit history, but because secured loans provide lenders with security, many are willing to lend to poor credit scorers but at a higher rate.

Other advantages of a secured homeowner loan instead of remortgaging include:

• Your current mortgage may carry large early repayment charges if you are tied in to a special offer rate period.
• The funds might be available quickly. It is possible to obtain funds via a non regulated secured loan within 5 working days although a regulated loan will take longer.
• A further advance or remortgage lender may be restrictive regarding the purpose of the capital raising - secured loans can be used for any legal reason (any purpose).
• You may have little or no equity in your home. Some secured loan lenders are willing to lend up to 125% of the value of the equity.

What are the disadvantages of a secured loan?

The rate of interest on a secured loan will be higher than on an ordinary mortgage and possibly on unsecured loans, because of the fact that the lender only has a second charge on the property and also to reflect the additional risk to the lender where the borrowers have a poor credit history.

This means that the total interest paid over the term of the loan can be much higher than on a shorter-term unsecured loan. Also, if you are using a secured loan to make purchases such as a car or new white goods for your home, the debt may persist well beyond the life of the goods financed.

Other drawbacks include:

• There may be penalties for early redemption.
• There are likely to be upfront costs like valuation and arrangement fees, although this can also be true of mortgage top-ups to finance consumption expenditure.
• The reduction in monthly cash-outflow may be an incentive to take on further debt. This is NOT a good thing at all!

Some people who already have secured loans may also be in for a nasty shock if they try to repay them early. Although the government has now banned rule of 78 charges, most people with secured loans over two years' old will still potentially face this hidden cost. The rule of 78 was a way in which lenders calculate how much interest you should have paid at any stage during the repayment period.

The key point is that using this rule the interest charged on the sum you have borrowed is NOT spread evenly over the number of payments you have agree to make. Thus in the early period of your homeowner loan's life span you would have been paying more interest and less capital, reducing the outstanding amount more slowly than you may have assumed.

If you think a secured loan is right for you, why not check out the interest rates available on secured loans now with Moneyextra's secured loans comparison service.

What are the alternatives to a secured loan?

A secured homeowner loan may not be the only solution to your financial situation and you should consider all the alternatives - you may find that there are cheaper options available to you or simply those that are less onerous and do not involve using your home a security for a loan.

Among the financial options you should consider are transferring credit card balances to cheaper cards. If you are looking for a substantial sum of money for, say, the construction of a home extension, then you should consider first a further advance or remortgage, which are likely to be available at a lower interest rate than a secured homeowner loan.

Among the non-financial solutions you should consider is cutting back your spending in order to manage your existing short-term debt more sensibly and pay it off. If you find this a struggle it is likely that while a secured loan may be tempting, it won't be the right answer for you and you should seriously consider debt counselling .

THINK CAREFULLY BEFORE SECURING OTHER DEBTS AGAINST YOUR HOME. YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON A MORTGAGE OR ANY OTHER DEBT SECURED ON IT.

21 August 2007 © Moneyextra.com

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