What's a homeowner loan? What should you be wary of? Neil Faulkner has the answers.
There are around 150,000 people with homeowner loans (second-charge or secured loans). These are loans on top of your mortgage that are also secured against your house if you fall into arrears.
The Office of Fair Trading (OFT) has been focusing on these recently. Calling them 'high risk', it said:
'All businesses within this sector should act with appropriate regard to consumer protection and fair practices. Our latest guidance reflects this, and we expect all firms to comply with it.'
Are unsecured loans lower risk?
Even with unsecured loans (aka personal loans) your property can be repossessed if the lender obtains a couple of court orders. It's not guaranteed that the court will grant the orders, but they're not particularly difficult to obtain.
I don't have figures on how many unsecured loans lead to repossession, but the fact that they are seen as lower risk by the OFT and some debt charities indicates that it probably happens less often than with secured loans. However, it's possibly just the size of unsecured loans, which are typically smaller, that stops lenders from repossessing so often.
Still, there are other advantages of unsecured loans. To start with, most have fixed rates, whereas secured loans normally have variable ones. When we say 'variable' here, we just mean that the rate might go up. It would be highly unusual for a lender to ever reduce your rate, even if the Bank of England lowers the Base Rate. We've seen this recently, as the Base Rate has fallen from 5.75% to 0.5%, but holders of secured loans have not had their rates reduced. They might see them rise when the Base Rate changes direction though.
Secured loans are expensive
If you borrow £10,000 over five years it costs around £12,000 to repay with the cheapest unsecured loans. (That's the £10,000 plus £2,000 in interest.) A top secured loan typically cost £13,300 or more - and remember that rate can go up.
An ominously large loan of £25,000 can cost around £30,200 over five years if you choose an unsecured loan, but £31,800 with a secured loan (or more if the rate rises). So it costs £1,600 more to opt for the secured loan over the unsecured loan.
Is re-mortgaging a better option?
Re-mortgaging is another option and can be a lot cheaper than a secured loan, but to make it cheaper you should be prepared to overpay for several years to reduce your debt faster.
Otherwise, the extra debt could hang on for more than 20 years. Yes, your monthly repayments will be lower, but in the end you'll likely pay more debt interest, which means overall you'll have less money!
Check that you can make free overpayments on your mortgage, and you should compare the cost of other debt options, too.
The cost of early repayment
Costs of early repayment for loans less than £25,000 should be similar. Two month's interest is standard. However, the lender may try to charge administration fees on top. Watch out for that.
If you have a loan of £25,000 or more, the lender will charge a great deal more. Typically, it'll charge six months' interest and perhaps a £200 fee on top.
Fees and charges
Secured loans tend to come with very big charges for simple things, such as sending you a standard letter. These charges are similar in nature to the bank charges that are currently being contested in court and in the House of Lords, in that they should only reflect the true cost to the lender but actually are very high. It's likely that bank charges will be ruled as unlawful and that will almost certainly mean the same applies to these.
Say 'No' to the optional insurance
Don't take out the insurance that goes with these loans, as lenders' insurance is ten to twenty times more expensive than it should be! If you want to protect your payments, search the Internet for independent 'income payment protection insurance' providers, which not only charge 1/10th or 1/20th of the cost, but tend to offer better terms and conditions. (Read about insurances that protect your income.)
It can all be a little seedy
Getting a secured loan can sometimes get quite aggressive with pressure-selling to people who can't afford it, and if the borrower falls into arrears it can get even nastier. That's why the OFT has been talking about these loans recently. If you ever feel that you've been treated unfairly - harassed, charged too much, misled, or whatever - you should complain. If you're not happy with the result of that complaint, take it the Financial Ombudsman Service. The FOS is free to contact and often forces lenders to compensate borrowers.
Is this the right thing to do?
Think very carefully before taking out any loan, particularly a large one, or adding to your mortgage. If you can't get the cheapest unsecured loans or a 0% credit card because of debt issues, you should get free advice from a debt charity first, such as National Debtline or Debtline NI. Often there is a much cheaper solution, and you'd be surprised how many different ways there are to borrow and to reduce your debts faster.
More: Top personal loans are getting cheaper! | You've got a debt problem
> Compare unsecured loans through lovemoney.com