Interest-only mortgages, secured against an asset can be a useful financial solution for a number of circumstances in order to keep the monthly repayments down, however, like many financial decisions there is a range of factors to consider.
This article will explore the differences between secured and unsecured loans, the advantages and disadvantages of interest only secured loans, typically how much can be borrowed, the lending criteria and the application process.
What are the Differences between Secured and Unsecured Loans?
A secured loan is a type of borrowing that, during the application process details of an asset are provided as security to the lender such as property, equipment or land.
The asset acts as collateral for the lender and in turn reduces the risks involved, that in the event of the borrower defaulting on the agreement, the lender could repossess the asset.
Secured loans often have more favourable loan terms than unsecured loans as the lender has some level of protection should the borrower’s circumstances change and can no longer make the repayments.
Unsecured loans are where an offer to lend is solely based on the personal circumstances of an applicant and therefore the debt is not associated with an asset. Examples of unsecured loans are personal loans, credit cards or bank overdrafts.
Unsecured loans can be useful in certain circumstances however the loan values available are usually capped and therefore are not often used for big projects or purchases. In addition, the interest rates are usually higher than secured loans, due to the risks to the lender.
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Advantages and Disadvantages of Interest only Secured Loans
Now that we have distinguished between secured and unsecured types of lending, let’s focus more on the advantages and disadvantages of interest only secured loans.
Firstly, let’s clarify what an interest-only secured loan is. An interest-only secured mortgage is a financial product that enables borrowing however the mortgage holder is only required to pay the interest due to the loan each month, during an agreed term. However, at the end of the mortgage term, the capital amount borrowed remains outstanding.
Advantages of Secured Interest-Only
- Lower Repayments – Interest-only mortgage repayments are cheaper than those on a standard, repayment mortgage however it is worth bearing in mind that once the mortgage term is concluded, the capital loan is still due and therefore a strategy to repay this will still be required.
- Lower interest compared with unsecured loans – Typically lower interest rates are applicable to secured loans due to the linked asset.
- Longer repayment terms – Usually secured loans offer longer repayment terms than unsecured loans that are often capped at seven years.
Disadvantages of Secured Interest-Only Loans
- Capital remains outstanding – The main downside of interest-only lending is that the capital must be repaid at the end of the mortgage term. Therefore, a repayment strategy must be in place and agreed upon with the lender before taking out the loan.
- Interest-only loans can work out expensive – As the capital is not being reduced during the term of the loan the level of interest charged will not decrease either therefore more interest is paid over the term compared with repayment mortgages.
- Riskier – As a separate exit strategy is required with interest-only mortgages, the repayment vehicle such as investments or pension funds could act in a different way to the plan therefore there may not be enough of a fund to pay off the capital when needed.
How much can I Borrow with an Interest Only Secured Loan?
As with standard mortgages, the amount that an applicant will be offered will vary depending on the personal circumstances of the applicant, the equity available within the property and the lender’s loan to value policy.
The equity within a property is the difference between the property value and the outstanding mortgage balance. Some lenders will have a minimum equity requirement as eligibility criteria for interest-only mortgages, often of £150,000 o first charge loans.
Can I Switch from a Standard Mortgage to an Interest Only Mortgage?
One way of obtaining an interest-only mortgage is to enquire about switching your financial product with your current lender. Bear in mind that your lender does not have to agree to switch products and even if they do, the lender may not offer the most competitive rates or terms, however, this could be a short-term solution depending on the circumstances.
Another matter to be aware of is that switching mortgage products may mean that any early redemption penalties or other similar fees are due. Therefore, depending on the personal circumstances of the applicant, it may be worth seeking expert assistance to explore the wider mortgage market in order to obtain the most competitive mortgage solution.
Which is better – Interest Only Second Mortgage or a Re-Mortgage?
Unfortunately, due to the complex factors with both types of financial product, which are relevant to the individual current mortgage and the personal circumstances of the applicant, it is not a straightforward question to answer. Factors to consider are:
- The terms on the current mortgage including the interest payable and if any early redemption penalty fees are due should a change be made.
- The level of borrowing needed.
- The personal circumstances of the applicant and if any changes in circumstances have occurred that will impact the access to borrowing.
Mortgage advisors are best placed to be able to advise the most cost-effective and appropriate approach in each situation and therefore if you are considering whether to obtain a second mortgage or to re-mortgage, it would be highly recommended to book a consultation.
Interest-Only Secured Loans Summary
As with any big financial decision, research and consideration of all of the factors concerned are needed, including a comparison of costs between various options.
Our specialised team of mortgage experts can provide guidance no matter what stage of the landlord journey you are at – either just starting out, or if you have plenty of rental experience however due to a change of circumstances, you require a tweak to your financial matters. Please get in touch to book a friendly, no-obligation consultation.
Call us today on 01925 906 210 or contact us. One of our advisors can talk through all of your options with you.