Before explaining some of the variations in loan features, you should also be aware that there are two types of second charge secured loans, namely regulated and non regulated. This is mainly determined by the purpose of the borrowing or type of property being offered as security and it affects the process of borrowing and the amount of regulatory protection you might get. After reading this section go to regulatory protection for loan borrowers.
Let’s get back to variations of loans – this might help you decide on features which may be beneficial to you.
Note: The information below is for general guidance as is not to be taken or relied upon as personal advice. Please speak to one of our mortgage experts or professional advisers.
Taking out a loan or mortgage involves weighing up the alternatives. For example, if your heart is set on a five year fixed rate that’s fine but it may come at a higher price. You may ultimately decide to go for a three fixed rate because it is so much cheaper. Starting with a wide choice opens up more alternatives and some lenders don’t offer all options. Keep an open mind and ask lots of questions before you decide.
Capital and repayment loans
This means paying back the capital you borrowed and the interest over a fixed term. When you get to the end of the agreed term you should have repaid the entire amount you borrowed plus you will have paid the interest each month. Remember, if you fall into any arrears or incur any additional charges these are added to your loan at the time and may incur interest so could mean there is an additional amount owing at the end of the term.
At the start of a capital and interest loan, the balance reduces slowly because you are paying back capital and interest at the same time. Most of your monthly payment goes towards paying the interest and a small amount of it goes towards reducing the balance. As the balance slowly reduces, less of your monthly payment is used to pay the interest on the balance and more goes towards reducing the amount you owe so the further you get in to the term of the loan, the faster the balance goes down.
Interest only loans
With this type of loan you are not repaying any of the capital you borrowed. You are just paying the interest on the balance each month. The advantage of interest only is that the repayments are lower for a comparable interest rate. The disadvantage is that you will still owe the full amount at the end of the term so need to ensure you have a means of settling the loan at the end or earlier if possible.
There are many reasons why an interest only loan might be appropriate but there is a real risk that, despite best intentions, plans don’t always work out as expected which could leave you with a big debt and no means to repay it. Many people are now coming to the end of their interest only loans to find they still owe a large sum and their mortgage company is demanding repayment. Often these are older or retired people where refinancing over another long period is not easy. For younger borrowers who can take the mortgage over a longer term (before retirement) the difference in monthly repayments between a capital and repayment loan and an interest only loan is often less than expected. If you are thinking about interest only, ask our adviser but consider how you will repay the loan at the end of the term, or sooner.
Standard variable interest rates (SVR)
This refers to the rate of interest you will be charged over the term of the loan which will be based on the rate of interest set by your lender at the time. Lenders can choose what the rate will be and whilst they will generally try to be competitive you are to a great degree in their hands. If base rates go up or down it is up to the lender how they react. One of the advantages of an SVR is that the lender charges lower or zero product fees or redemption charges. This means the costs associated with taking out the loan or paying off early may be lower but your interest rates could rise to what ever rate the lender thinks is fair and reasonable.
Base rate tracker loans (Tracker)
These loans have a variable rate too. However the rate is set by the bank base rate so lenders do not control it. This gives some borrowers greater comfort and because base rates have been so low, those who took out base rate trackers many years ago are enjoying interest rates which are simply not available now. The rates tend to be quoted in terms of “base plus X %” so in the case where base rate is 0.5% a Base plus 2% rate would equal 2.5%. If the base rate rose to 1% the tracker rate would become 3%. The lender fees and early redemptions charges tend to also be lower on products such as this.
Fixed rate loans
These have a period of the loan, normally at the start, where the lender agrees to fix the rate you pay irrespective of what happens to the underlying base rates. Typically the options range from 1 to 5 years after which the rate reverts to the lenders standard variable rate. Fixed rates are good for borrowers who want to have some guarantee their monthly repayments won’t change for a certain period of time. However lenders may charge higher application fees or early repayment charges.
All of these need to be taken in to account when deciding on which product to take which often becomes a combination of gambling on whether rates will go up or down and a mathematical exercise to compare the costs of any extra fees against the potential savings on the interest rate. Our mortgage professionals are there to help with help with the maths but as an example, you may pay higher fees and higher early repayment charges if you take out a five year fixed rate and than settle it after two years. If that scenario is likely, consider if a two year fixed rate deal may be more appropriate.
Capped rate loans
Capped rates refer to an interest rate which is guaranteed not to rise above a pre agreed annual percentage rate. There may be a variety of options including tracker and SVR’s but in each case the lender will cap the rate so you don’t pay more. The lender is effectively gambling that the rates it borrows at don’t go too high, just like with the fixed rates. Again, to offset those risks the lender may charge higher initial fees and early repayment charges. Capped rates are less widely offered so may restrict your choice of lender and rates.
Discounted rates loans
These are useful for borrowers who need a lower repayment at the start of the mortgage and are prepared to pay more later on. Effectively you pay less interest at the start and the short fall is added on later. You could end up paying more interest over them of the loan.
Choosing a suitable product variation will depend on your circumstances and the products available at the time. Always seek the help of a mortgage professional who has access to a panel of lenders which represents the whole market. If the loan is secured on your main home it is highly likely that you will need to take full advice from one of our experienced underwriters.