Equity Release vs. A Second Charge Mortgage

Equity release is a form of loan, available to those aged 55 or over who want to gain access to the equity that’s built up inside their home, without having to move house or downsize.

You also do not need to repay the loan until after you pass away or move into care.

You get to release money, without ever having to sell up or move home and will never be asked to leave, as long as you stay within the terms and conditions of your loan.

You will be charged interest on your equity release loan, which will continue to compound as the years go on.

Your loan will continue until you pass away or move into a care home, which can be decades depending on how old you are when you first take out your equity release loan [1].

Once you do pass away or move into a care home, your home will be sold and the proceeds from the sale of this house will pay off the loan.

The proceeds from the sale of your home should be more than enough to cover the cost of the loan, including any compound interest that’s built up. If it doesn’t, the lender will step in to pay the difference as part of the ‘no negative equity guarantee’ [1].

What is a lifetime mortgage?

A lifetime mortgage is the most popular form of equity release, allowing individuals the chance to release equity without having to sell your property.

You get to remain living in your home for as long as you want and do not need to repay the loan until after you pass away or move into a care home [2].

What is a home reversion mortgage?

A home reversion mortgage works a bit differently to a lifetime mortgage, in that you do have to sell a percentage of your home to a lender if you want to gain access to the equity inside your home.

You will be selling a percentage of your home to the lender for less than market value. When you come to sell your home, you will also receive less as you will be selling a smaller percentage of your home.

However, the advantage of opting for a home reversion plan is that you will not be charged interest on your loan.

What Is a Second Charge Mortgage?

Taking out a second-charge mortgage allows individuals to take out a second mortgage on their property, which is then able to fund things like home renovations or extensions.

This is a great option for anyone who wants to remain living in their home as they grow older, but also needs to spend money on the home in order to make it suitable to live in as they age.

Second-charge mortgages work differently to remortgaging. When you take out a second charge mortgage, your existing mortgage will remain in place. Instead, you pay both mortgages at the same time.

When you take out a second-charge mortgage, the equity inside your home is used as collateral.

You get to remain living in your home for as long as you remain repaying your mortgages. Your home is used as security by your lender until you repay the loan.

If you fail to keep up with your repayments, then you run the risk of having your home repossessed.

What are the main differences between a second-charge mortgage and equity release?

There are some key, main differences between taking out a second mortgage and taking out an equity release scheme.

If you are considering taking out either type of loan, then it is important to understand the key differences so that you make the right decision for you and your personal circumstances.

1. You will maintain your pre-existing mortgage

To begin with, when you take out an equity release loan, it is mandatory that you must have paid off the majority of your traditional mortgage.

However, when it comes to taking out a second charge mortgage you are able to do so alongside your traditional, pre-existing mortgage.

2. Qualification criteria

Secondly, you have to be aged at least 55 or over in order to qualify for equity release loans across the UK. However, when it comes to second charge mortgages, you are able to take out a loan much younger.

3. One lump sum vs drawdown payments

Likewise, second-charge mortgages come in the form of one lump sum. When it comes to equity release loans, you’re able to opt for either one large lump sum or a number of smaller payments, known as a drawdown plan.

4. Mandatory repayments

When you take out an equity release loan, you do not have to make any payments to pay off the loan until after you pass away or move into a care home.

When it comes to a second charge mortgage, you will have to keep up with your mortgage repayments, or stand the risk of having your home repossessed.

What are the risks of taking out a second-charge mortgage?

Whilst it’s important to understand the key differences between equity release plans and second-charge mortgages, it is also important to look at any risks associated with taking out a second charge mortgage.

As with any loan, there are always risks involved. Whilst these might not be big enough to avoid a second charge mortgage altogether, they are important to consider.

1. Typically higher interest rates

Taking out a second-charge mortgage will typically involve higher interest rates than on your pre-existing, traditional mortgage. You are not able to match your second charge mortgage interest rates to your pre-existing mortgage interest rates.

This is why you should always discuss your interest rates with your financial or mortgage adviser prior to signing anything.

2. More expensive than a traditional mortgage

Likewise, taking out a second-charge mortgage means you will end up repaying more than if you were to take out a traditional bank loan.

Likewise, a second-charge mortgage will most likely always cost you more than if you were to pay the early exit fee from your traditional mortgage.

3. Repossession

Finally, taking out a second-charge mortgage means that you run the risk of having your home repossessed if you fail to keep up with monthly mortgage repayments.

This is a huge risk, so you need to be sure that you are able to make these payments before taking out a second-charge mortgage.

What to Consider Before Choosing Second Mortgages or Equity Release?

There are a number of different things to consider before choosing to take out a second charge mortgage.

For example, you should always check if you are able to simply take out an advance on your pre-existing mortgage before opting to take out a second-charge mortgage.

Likewise, before taking out a second charge mortgage, you should always seek professional advice from a qualified financial adviser.

Your financial adviser will follow the rules and standards set out by the Financial Conduct Authority (FCA). Your adviser will work closely with you to work out the best option for you and will never force you or put pressure on you to take out a certain loan.

Getting formal, professional advice from an equity release adviser should ensure that you limit the risk associated with taking out your loan. It is important that your financial adviser shops around to get you the very best deal. You can also do this by researching online!

You should check for the best interest rates and should also compare their annual percentage rate of charge (APRC). You should also take into account the duration of the mortgage or loan and the total amount that you will need to pay back.

You will also need to consider whether or not there are any early repayment fees, and how these might come into effect if you want to repay your mortgage or loan early at any point.

How much can I borrow on a second mortgage?

The amount you are able to borrow from your home depends on the amount of equity you have built up in your home. A second mortgage will use the equity in your home as security against your loan.

This means that you will be able to borrow a significant amount of money, but you will also have two mortgages.

The equity inside your home includes the value of your home, minus the mortgage still left to pay. Each lender will offer you different deals and different amounts, which is why it is important to shop around.

Are second-charge mortgages expensive?

Yes, second-charge mortgages tend to have higher interest rates compared to traditional mortgages. This means that they can end up being more expensive than your traditional mortgage, as you will end up owing a lot more.

It is important to understand that second-charge mortgages involve mandatory payments. If you miss a number of payments, then you run the risk of having your home repossessed.

If this were to happen, your original mortgage would be paid off first, before your second charge mortgage. For this reason, second charge lenders tend to set higher interest rates.

There is no doubt that second-charge mortgages are considered higher risk compared to some alternatives.

However, for a lot of people across the UK they are a great option. Always speak to a financial adviser before making any decisions.

Can you lose your house with a second-charge mortgage?

As discussed above, you can lose your home through a second-charge mortgage. Second-charge mortgages involve mandatory repayments, as with your traditional, pre-existing mortgage.

If you fail to keep up with these payments then you do run the risk of having your home repossessed by the lender. This means that they will take your house away, you will no longer be the owner and you will need to move out.

This is why it is crucial that all second charge mortgage lenders run affordability checks on all applicants, so that they can be confident that this will not happen.

Remember, you will have to pay your second charge mortgage alongside your pre-existing mortgage, so your monthly mortgage repayments will increase significantly.

It is not only important to consider whether you can afford these monthly repayments now, but it is also important to consider the affordability of these payments if your circumstances were to change.

Whilst no one has a crystal ball, it is important to consider whether or not it’s likely that your income will change, mortgage interest rates will go up or whether or not your expenses are likely to rise.

It is always important to check whether or not you would still be able to pay off both mortgages if one of you were to lose your job, or if interest rates were to rise.

Doing an affordability check is always necessary, but it is also important to check your affordability threshold if your circumstances were to change.

What are the other alternatives?

If taking out a second charge mortgage or an equity release scheme simply is not for you, due to the risk element or high interest rates, then there are a range of other alternatives which you should carefully consider.

Before making any decisions, you should speak to a financial or equity release adviser.

They will not only discuss the ins and outs of equity release and second charge mortgages, but will also discuss some of the below alternatives with you too.

1. Downsizing

If you need access to some extra money later in life, then you might want to consider downsizing. Downsizing involves selling your home and buying a smaller, cheaper property [3].

By doing so, you will bag some of the additional cash from the proceeds from the sale of your home that was not spent on the new property.

Depending on how much your house has increased in value and how much you are willing to downsize, this could be a significant amount of money [5].

Downsizing is not for everyone, and will involve having to sell up and move home later in life. However, it does mean that you are not taking out a further loan, which makes it the least risky option.

Rather than moving to a smaller home, you could opt to move to a less expensive area, where you might be able to get more bang for your buck.

2. Get a part time job

If you are aged 55 or over and need access to some additional cash, then you might want to consider getting a part-time job.

Whilst the idea of working throughout your retirement might not be ideal, it is a surefire way of ensuring that you are financially stable throughout your retirement.

This might be able to fund a better lifestyle throughout your retirement if your private or state pension does not cover your needs.

Depending on your skills and your experience, there are a number of different jobs that are suited to those in retirement.

You might choose to work full-time, but we would always recommend getting a part-time job throughout your retirement, as taking on a full-time job later in life can be a huge commitment.

There are a number of suitable, part-time jobs including working in a cafe, working in a garden centre, working on reception at a GP or dentist surgery or working as a taxi driver.

Not only will getting a part-time job in retirement ensure that you are financially stable throughout your retirement, but it will also help to keep your body and mind healthy, too.

In fact, a recent study has found that getting a job in retirement can even help to reduce the chances of you getting certain diseases such as Alzheimer’s disease.

3. Rent out a room

If you have a home with spare rooms, then you could choose to rent out one of your rooms to someone you know, such as a friend, a child or a grandchild. [4]

Getting on the property later for many young people is often tricky, and rental prices are through the roof.

So, you could always offer a loved one the chance to rent out one of your rooms, which would not only help them but would also provide an additional income for you later in life.

If you are going to opt for this, then it is important to rent your room out to someone you know, or someone you trust.

You should also set clear boundaries and rules with this person, as to avoid any issues.

The Government even have their own Rent a Room Scheme, which lets you earn up to £7,500 a year (tax free) from letting you a furnished room in your home [4].

Take out a personal loan

Taking out a personal loan might be a better alternative to taking out an equity release loan or a second charge mortgage, as there is usually less risk involved.

You might be able to get cheaper interest rates on a personal loan, but will also have to repay the loan back earlier than you would if you were to opt for an equity release loan.

Talk to Equity Release Warehouse

If you are confused about what type of loan you should opt for, or are confused about the differences between an equity release loan and a second charge mortgage, then you should speak to a member of the Equity Release Warehouse team.

We are a team of specialist advisers who are on hand to explain the ins and outs of equity release, whilst recommending the best products and lenders for you.

Our team are not there to put any pressure on you to make a decision. Instead, we are simply here to provide you with all of the necessary and relevant information.

For more information on equity release loans and second charge mortgages, speak to a member of our team for free by calling us on 0330 058 1579 or by visiting our website for free.

References

[1] https://www.lloydsbank.com/mortgages/equity-release-mortgages/how-does-equity-release-work.html

[2] https://www.aviva.co.uk/retirement/equity-release/lifetime-mortgage-explained/

[3] https://www.equityreleasewarehouse.com/guides/should-downsize-retirement/

[4] https://www.gov.uk/rent-room-in-your-home/the-rent-a-room-scheme