Securing a loan to your current home
A homeowner loan, or secured loan, is so-called because it’s tied to the home you own. This means if you stop making your repayments, the lender could repossess your property to claim back what you owe them.
In this way, your house provides an extra layer of security for lenders. So they may be more willing to offer you larger sums of money with lower interest rates - even if you have a less-than-perfect credit score.
Equity and LTV
Equity is one of the main factors that affects how much you can borrow. It relates to how much you’re left with once you deduct your mortgage balance from your current house value.
The higher your equity, the less risky you’ll appear to lenders. This means they're more likely to offer you more competitive deals.
Here’s an example of how to work out how much equity you have in your property:
House value £200,000
Mortgage balance £150,000
£200,000 minus £150,00 = £50,000 equity
You can work this out as a percentage by following this formula:
£50,000 equity / £200,000 value = 0.25
0.25 X 100
= 25% equity
In this example, your loan-to-value (LTV) makes up the remaining 75%. Your LTV relates to the portion you owe on your mortgage.
The risk of missing repayments
Lenders are keen for borrowers to have as much equity as possible because it adds an extra layer of security for them. For instance, if you stop making your repayments, they could claim back owed funds by repossessing your property.
If this was to happen, your mortgage provider would be the first lender to receive payment. Any excess funds would go towards your secured loan. Then any surplus cash would go to you.
However, if there isn’t enough money to clear your secured loan in full, you would still owe whatever is remaining. There’s a greater risk of this happening if there’s little equity in your home (and a large outstanding balance).
This is why lenders tend to offer their best deals to those with more equity. They can be more confident that they’ll get their money back in full.
Applying for a mortgage
A homeowner loan shouldn’t affect your future mortgage application if it’s paid in full when you sell the house upon which it’s secured.
This means you won’t have to include it in your monthly outgoings on your application form (as you’ll no longer have to make these repayments). As a result, it shouldn’t affect the lender’s decision.
However, if you don’t receive enough funds from the house sale to clear it in full, then you will still owe the remaining balance. This could affect your affordability for a mortgage.
How much can I borrow?
How much you can borrow depends on a number of factors, including your individual circumstances and the lender’s criteria. Lenders may look at:
- Your income and outgoings
- Credit history
- Property’s value
- The equity you have
Generally, the higher your equity, the more money you may be able to borrow. But secured loans can affect the amount of equity you have, which could have an indirect impact.
For example, let’s say your house is worth £200,000 and you have £50,000 left to pay on the mortgage. This would give you 75% of equity, and a loan-to-value of 25%, which is pretty good.
But if you were to add a homeowner loan on top of your mortgage, your equity would decrease as your loan increases. So it’s a balancing act that you need to be mindful of so you don’t end up overstretching yourself. It could also mean you’re not able to borrow as much as you thought.
Other important considerations
If your outstanding mortgage balance and secured loan leave you with very little equity in your home, it may be best to wait a while before moving. By clearing as much of your debt as possible, you’ll improve your LTV and open yourself up to better mortgage deals.
Keep in mind there may be a charge for repaying your homeowner loan earlier than initially agreed. You’ll need to pay for this from the proceeds of your property sale too.
If you don’t have any equity in the property, there may be some lenders who agree to transfer the loan to your new property. There may be a fee for this, though, and it could also depend on the loan-to-value of your new home.
Always remember to shop around and compare quotes to find the best deal for you. You can do this by visiting comparison websites, as well as going direct to lenders or using a broker. And bear in mind, if you consolidate your existing borrowing, you may be extending the term and increasing the amount you repay in total.
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Homeowner loans are secured against your property.