When you hit 18 and land in the adult world, unless you’ve been fortunate enough to have parents that sit you down and explain the way the financial world works, including the mortgage industry from a secured / unsecured, business, non-business, bridging finance and so on – you’d be forgiven for feeling like you’ve just landed on a new planet.
The industry as a whole from the outside looks extraordinarily complex and if you already have a phobia for numbers the idea of trying to borrow money for what you need, can be a real concern. Especially given that there are lots of ways you can borrow money today.
Whether you’re just looking to boost your knowledge of what options you have or you’re looking for an idea of what’s out there for practical help, we believe that these topics are underserved from an educational perspective, so we truly hope our explanations help.
We’re going to cover some really key terms that should give you a nice understanding of the real estate financing and commercial real estate financing world.
Here are the terms that we’re going to cover:
First charge mortgage, what is it, and why would you need one?
The first charge market is well-stocked providers offering thousands of products for people in different circumstances, even though the housing market is relatively flat at this time, there are an awful lot of options for buyers which is great for consumer choice.
You would need a mortgage if you don’t have all of the money to buy a property; given the average house price in the UK is over £150,000 and the average salary in the UK for adults over the age of 18 sits at below £30,000. If you want to own a home, chances are you’ll need a mortgage
First charge is really only a term used by lenders, to Joe public. What it is in simple terms is a mortgage against a real estate asset or piece of land (this could be commercial or residential). The first part refers to the fact that it’s the original loan against the asset. If for any reason the holder of a first charge couldn’t pay, the first legal charge would be settled first before any other debts by a sale of the asset.
You can also have a mortgage for commercial purposes too. You’d typically take out a commercial mortgage to acquire, redevelop or refinance.
You might be a builder who has seen a really great patch of land to build some property, unless you had all the money you need to, acquire the land, get all the material etc, you’d need a commercial mortgage, for any business you’d need a really solid business plan, where and when in your plan you’ll make money, in this example it’s usually the sale of the properties.
Typically, on commercial property first charge mortgage rates are higher than residential property- why is that, you ask? The simple answer is a risk for the lender. When a person looks to raise funds from a lender for a regular residential mortgage the things that are looked at the most are affordability, can the borrower pay it back, do they have a significant credit profile to afford this and do they earn enough to cover the costs as well as other costs for example dependents, historical credit like loans or credit cards.
Commercial lending relies on many other factors including the individual or businesses eligibility for the loan, factors like an exit strategy for shorter-term loans bridging loans, business plan, sales projections, market forecasting and other factors that have a greater impact on the risk.
You’ve inherited some land at the back of your property, the person who you inherited the land from has full planning permission (which in the UK typically lasts for 5 years) to build two new houses, you have a few options, build them yourself, or sell the land with planning to a developer.
You decide that you’d like to build the houses yourself to sell, you don’t have enough money to do it without finance, so you look at getting a commercial mortgage.
You loan £100,000 which is secured against the land you cover the remainder of build costs yourself which for this example is £30,000.
You build the houses which all goes well and buyers complete on the properties making you tidy profits. In that situation, you don’t require more money, but if you underestimate build costs or you come into trouble during the build where you need to secure alternative funds, you can look at second charge loans or even bridging loans. We’ll cover what they are separately.
What is the definition of a first charge mortgage?
A first charge mortgage is most commonly known as just a mortgage, it is taken out to purchase land or property and in most scenarios is over a period of between 15-35 years. There are many benefits to this for consumers and lenders:
- It’s often a fairly cheap way to borrow money and is often at a lower cost than renting the property (depending on your circumstances)
- To the lender, it’s a secure way of lending money, given that if the borrower defaults, it will often regain all of the cost of the mortgage through the sale of the property
What does first legal charge mean?
This term is exactly the same for both commercial and residential property. The first legal charge is the lender who will be owed money first from the asset.
You bought a home 10 years ago with your bank which for the purposes of this example you’re still with today. They are your mortgage provider and have “first legal charge” over your property.
You paid £100,000 for the house paying with a £30,000 deposit, meaning you mortgaged £70,000 @ 2% fixed for 10 years (25-year mortgage total) paying back £297 per month.
Five years ago you decided that you wanted an extension, your house price has gone up, coupled with you owning more of the house than you started, you decide to take out a second charge instead of an unsecured loan due to the lower rates as it fits in with your circumstances.
At the point of the second charge loan you owed £58,651, you borrowed an additional £20,000, but because the rate of interest was higher from your bank, you decided to take the second charge to a competitor who offers you a rate of 4% per annum for your £20,000, you pay this back over 10 years at the cost of £202.49 per month.
A year goes by, you’ve continued to pay your mortgage but have struggled to keep up with repayments with your second charge. Other circumstances happen, and you are unable to make any repayments, the second charge and first charge provider after going down all of the relevant avenues for all parties come to the conclusion you have to sell the property in order to settle the balances owed.
The property is sold for the market value – £120,000.
The first charge provider is the legal first charge, so the owed amount would go directly from the buyer to the first charge provider at this point £56,242, then the second charge provider would get their money back including interest at the point of the sale £21,000 – Leaving you the final amount minus fees, charges, penalties etc £40,000.
This is a worse case example without estimating fees or accounting for the property potentially decreasing in value etc. Usually properties that have been recovered in this way go to auction where rarely they reach the full value, but for this example to make it simple we have given the sale price of £120,000 – if you are reading this because you’re in a similar situation and Google has placed you here, it is always best to discuss your options with your provider or broker, as well as utilising free resources such as www.gov.uk or the money advice service https://www.moneyadviceservice.org.uk/en which are free impartial help services.
What does a first charge repayment mortgage mean?
In our example above, the mortgage we used was a repayment mortgage; this means you pay off over time both the capital of the loan and the interest in a single instalment.
There are lots of different variations to this. The most common and popular at the moment is a fixed rate for a set period. Usually, fixed mortgages last 25 years and upwards but the duration of which you can fix for isn’t the full duration of the mortgage- typically you can fix from anything between a year to five years, but recently with Brexit and other global factors, there has been a rise in longer-term fixes.
After your fixed period is up, it’s really vital to have another deal lined up, either with your current provider (often they will offer you incentives to stay) but if you don’t put that process in place, you will automatically jump up to a higher rate. Given nobody likes to pay more for the same thing, it’s prudent to begin shopping around for a new deal anything between 3-6 months from the end of your current deal. There are plenty of price comparison sites out there. If you prefer the personal touch and expertise of a financial advisor, you can always talk with your local mortgage broker who will often have relationships with lenders that may give them access to preferential offers. With that being said, it’s always good to shop around to find the deal that best helps you with your short and long term financial planning.
What is a loan secured on a house?
A loan secured on a house is often referred to as a second charge loan or a homeowner loan or just a secured loan.
As the above examples if it’s a “second charge”, then it sits underneath your first charge mortgage as a legal priority when it comes to recovery of the debt.
Secured loans are often used for business and personal circumstances ranging from securing funding for a business venture, to simple home improvements. When you make an application for a secured loan against a house, like any loan, you will be asked what for the loan is.
Loans secured on a house offer lenders the security of an asset and borrowers the backing of having that asset on offer to the lender, which often means the rate of interest is, in many cases, lower than in other lending scenarios. This isn’t always the case, and like all the examples we’ve gone through, you should always asses the best possible options for you.
There are many reasons why this method of finance would suit you. Essentially, the loan is usually over a longer period making repayments lower and at a lower rate too. In many cases, these loans are typically for consolidating debt, major home improvements or unexpected structural repairs like a costly new roof.
What is a second charge mortgage?
You might think, why would anyone want a second mortgage when they already have one? Well, they’re more common and useful than you think.
To start with the definition of a second charge mortgage is exactly the same as a first charge, with one key factor – the first legal charge still sits with the first charge mortgage provider, so if things go wrong the first charge provider gets paid first and the second charge provider second.
Similar to second charge loans, second charge mortgages sometimes contain greater risk, given that the loan to value margins of failure would swing heavily towards the first charge.
That risk is always reflected in the rate, so you can pay a larger interest rate on second charge mortgages. However, in some situations, the second charge rate is lower or has a better incentive than the first.
Second charge mortgages are a great way of releasing equity from the property, again like other finance options, they can be used for many different reasons.
Typically, the amount you can borrow on a second charge mortgage can vary depending on your circumstances but is between £1,000 and £50,000.
Essentially, you’d borrow this money over the remaining period of your mortgage or less.
If you’ve set your sights on a second charge, it’s really important to shop around. There are plenty of calculators out there that can help you make the decision of what will work best for you and your circumstances.
With all of the examples of finance we have talked about here, it’s really important that you know the option that works best for you and that you don’t go into any financial decision thinking any one option is a last resort or the only option you can take.
Like any decision you make in life, research is always key, speaking to a broker, watching how-to videos or even using webchat or face to face chats with your bank and ever talking to friends and family is always good. Money can sometimes be a taboo subject with people even though the decisions you make are often some of the most important you can make. They can make or break you financially. After all, you look for reviews on the food you eat, the holidays you book, you talk to friends about all these things too seeking advice and understanding, so why not with your mortgage or the loan for your business? You never know you might just find a better solution than the one that was in your mind.
The conversation – If you are ever in any financial difficulty it’s really important that you seek help immediately, closing the door on your problems or waiting for a rainy day never really solved anything, if you talk to your finance providers often they can point you in the best place for help. Nobody wants to see people default on payments or lose their homes, but these things happen, things go wrong, scenarios happen that are out of our control, so if you’re going through this it is so important that you talk with:
A – your friends and family
B – your finance providers
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