We live in a society in the UK today where consumer debt stands at record levels and seems to be increasing. According to the latest figures from Standard and Poors and MoneyBasics, the average level of debt, including mortgages, for every person in the UK is £24,505. This is clearly quite alarming as many people have no debt at all, which means that a significant proportion of the population have debts well in excess of the average figure.
There are many forms of credit available to consumers in the UK today. These include credit cards, store cards, hire purchase, secured and unsecured loans and mortgages. With an increasing number of providers offering various credit options, all of whom are competing for the same business, it can be extremely confusing for the average man in the street to compare not only the different types of product, but also to select one particular provider from the vast array available on the market.
There are a number of factors which should be considered when choosing a loan or credit agreement. These may include; availability or speed of completion, monthly repayments and the term of the loan. Generally the longer the term of a loan, the lower the monthly repayments are. However, interest would be charged over a longer period which could significantly increase the overall amount to be repaid. Another important factor to consider is the Annual Percentage Rate, or APR of the loan. The APR is the standard adopted by the finance industry to reflect the true cost of the loan and includes all the interest together with any other charges. These could include broker fees, admin fees, valuation or search fees etc and must be included in a calculation of the APR.
It should also be considered, however, that many loans today calculate interest on a daily or monthly basis rather than annually, despite the fact that APR will still be shown to compare costs. Daily interest loans can work out a lot cheaper than the equivalent annually charged contract because, as the name suggests, interest is added daily on the outstanding balance, rather than just once at the beginning of the year and therefore as repayments are made and the balance reduces, less interest is charged in later months.
Once it has been established that a loan is required, there are two main options available:
1) Unsecured Loan
An unsecured loan is one where the lender has no rights over any property owned by the borrower (although it is worth noting that in the case of default, the lender may be able to seek recovery of the money via the courts by placing a charge on your home). The lender depends on the borrower’s obligation to pay. As there is no security for the lender, the interest rate charged is likely to be higher than that on a secured loan, due to the risk being greater. It is usually the case that unsecured loans are for lower amounts borrowed over a shorter term than would be permitted with a secured loan.
2) Secured Loan
A secured loan provides security for the lender, not the borrower, as it requires the borrower to provide some form of security for the loan rather than just a promise to pay. The security could take a number of forms including: the deposit of goods, the retention of ownership of goods (this is the case with Hire Purchase agreements) or, as is often the case, by taking a legal charge over a property in the form of a mortgage or second charge. In most cases, this will be the borrower’s home.
If a secured loan, or mortgage is taken, the borrower should be aware that, although the property is still in their possession, it can be repossessed by the lender at any time if the repayments are not maintained according to the terms of the loan agreement. The property would then be sold to recover the balance of funds outstanding along with any additional costs incurred. Any loan of this nature must include the wording: your home may be repossessed if you do not keep up repayments on a mortgage or other loan secured on it.
There are two main types of secured loan on property. These are a mortgage (or re-mortgage) or a second charge mortgage.
A mortgage/re-mortgage is usually the cheapest of these alternatives as the lender will take a first legal charge over the property. This means that if the property is sold, the lender is the first in line to receive any proceeds. Where a borrower already has a mortgage, this route is not always possible or practical as many mortgages have tie in periods with early redemption penalties payable should the loan be repaid in the early years. These penalties can be significant and may well cancel out any benefits obtained from re-mortgaging.
If this is the case, then it is possible to take out a second legal charge mortgage. With this type of loan, if the property is sold, the lender will take second priority for payment behind the first mortgage lender. As this increases the risk for the lender, the loan would usually be charged at a higher rate.
In conclusion, all of the previously mentioned points are important when applying for a loan or other form of credit, either for a purchase, or existing debt consolidation. Before any agreement is entered into, the borrower should consider the cost of the loan and the affordability of the repayments. In the case of debt consolidation, where unsecured debts such as short term loans and credit card balances are combined with home loans, it is important to remember that although monthly payments may be reduced significantly, the new loan is usually for a much longer term and interest is charged over a longer period, making the overall cost much greater than the original debt.
The points raised in this article are for information purposes only and should not be taken as advice. If you have any doubts or questions regarding any loan agreement, you should always obtain further, independent advice.