What are the different types of loansPublished: June 18, 2018
You need to be totally sure that you choose from the right types of loan to suit you. When you contact Loan.co.uk we will be happy to give you advice on the best type of loan for your needs and circumstances, meanwhile, here is a quick overview from loan.co.uk to help you understand the differences between the different types of loans and mortgages that are available.
Helping you buy property or land
One of the most common types on loan around, a mortgage is designed to help you buy land and property. Whether you’re a first time buyer or up-sizing to a bigger home, the chances are you may not have the funds you need to buy a property outright and that is where a mortgage comes in.
Long repayment periods
Because buying a property is a large financial commitment, no one is expecting you to pay it back right away. Mortgages can be paid back over long periods, usually spanning decades. The most common mortgage terms are 25-30 years. The longer the term, the lower the repayment will be each month, but the longer you spread out your repayments, the more interest you will end up paying in total.
Some homeowners decide to make overpayments on their mortgage. Making mortgage overpayments simply means that you voluntarily pay more towards your mortgage than the amount originally agreed by your lender. A mortgage overpayment could either take the form of regular overpayments (for example, your monthly payment might be £1,000 but you choose to pay £1,100 each month instead, making a monthly overpayment of £100).
Or, you could choose to make a one-off lump sum overpayment. For example, you could decide to make a £1,000 overpayment one month.
The aim of overpaying is to repay the mortgage debt more quickly, so that you reduce the total amount of interest you pay and be free of your mortgage quicker than the typical 25-30 year term.
You will need to put down a deposit
Most mortgages require you pay a portion of the house price value up front – typically 10% to 20% (although there are some that require less). This is a demonstration of commitment to the lender of your ability to keep up with the mortgage repayments.
Typically lower interest than other loans
As with most loans, you will pay interest on the money you have borrowed. With mortgages, the rate of interest is typically fairly close to the base interest rate set by the Bank of England, but it can vary depending on what type of mortgage deal you have chosen. Even though the rate man be low, you can pay large amounts of interest overall due to the size of the loan and the length of time you need to take to pay it back.
Choice of ways to pay interest
There are typically two ways to pay interest on a mortgage. One is called a ‘fixed rate’ and the other is often known as a ‘tracker’. A fixed-rate mortgage is just as it sounds, the interest rate is fixed for a period of the loan. This can advantageous if the rate is low and means that if the base interest rate rises in that period, your mortgage interest rate will be unaffected.
A tacker rate mortgage is a type of variable rate loan. A tracker rate mortgage will follow (or ‘track’) the movements of the base interest rate and adjust your mortgage interest rate in line with these changes. If the base interest rate is high, this can be useful as it will follow the rate down as well as up, so you could pay less in interest, but it could also mean you pay more if it rises.
A mortgage is secured against the purchased land/property. It is important that you keep up to date with your mortgage payments. Failure to keep up to date with your repayment may result in your property being repossessed.
Move your mortgage to another lender
When you remortgage your home, you switch your existing mortgage to a new deal, either with your existing lender or a different provider and often through a remortgage broker. It does not mean you move home, but the new mortgage is still secured against the same property.
Helping you get a better deal
A remortgage can help get you in a number of ways, including:
1. Reducing the interest rate on your mortgage
Has your mortgage been with the same lender for a number of years? If so, the chances are that there is a more competitive mortgage out there that is suitable for you and your needs. Because a mortgage is usually for a large amount with a long term (amount of time to repay it over), even a relatively small drop in the interest rate could have a big effect on the amount you pay each month.
2. Fixing your monthly payments so you are protected against future interest rate rises
If your current mortgage rate is variable, should the Bank of England or your lender decide to raise the interest rate, you will probably have to start paying out more on your mortgage each month. By switching to a mortgage rate with a long fixed-rate period you will be able to budget with greater certainty, well into the future.
3. Replacing a mortgage deal that is about to end with another one
When you take out a mortgage, it is common to choose an introductory deal, such as a low, fixed rate or a low tracker rate for a set amount of years (often between two and five) from the start of the mortgage.
When this special deal ends, your mortgage will usually revert to the lender’s standard variable rate. This can often be higher than other rates that you will find on the market, but the lender is counting on you to not make the effort required to check if switching to a new mortgage deal would save you money.
However, with a mortgage broker such as Loan.co.uk to search the mortgage market for you and match you to a loan that would suit you and your circumstances, you would have to put in minimal effort to be rewarded with a remortgage that could save you a significant amount of money.
4. Consolidating debts into lower payments
If you have many small loans, balances on credit cards or maybe an overdraft, it can gradually become quite a drain on your income each month. You may be able to take out a consolidation loan to pay off all the various amounts owed, but depending on the amounts involved, you might not be able to take out a large enough personal loan to cover them all. If you have a large percentage of equity in your home (that is free and clear of any secured loans) you may be able to take out a fresh mortgage that pays off your existing mortgage and your other existing debts. This could cut your outgoings each month.
5. Raise cash for home improvements
If you are planning expensive improvements on your home, a remortgage could help you to tap into the equity you have in your property so that you could fund the changes that you would like to carry out, from a new bathroom and kitchen to a loft conversion or extension.
More equity could mean an even better rate
For example, let us say I want to remortgage my home. The more equity I have in my property, the less I would need to borrow against the value of it (called ‘loan to value’ or LTV). This lowers the risk to lenders, meaning they could offer an even more competitive rate.
Please note that if you decide to move your mortgage to a new one your existing lender may charge an early repayment charge (ERC).
A second mortgage is also known as a secured loan, homeowner loan and second charge mortgage.
Second mortgages are guaranteed against your property
When you take out a second mortgage, you are making a promise to use your property to pay the money back if you cannot repay it in the normal way. Second mortgages are a type of loan that you can take out in addition to your existing mortgage, so if you take one out, you will have two loans that are secured against one property. That is why second mortgages are usually aimed at homeowners who want to borrow relatively large amounts (typically £15,000 – £250,000 ).
Second mortgages are not totally dependent on your credit rating
Banks and other lenders can be more willing to lend to you if you offer security, in this case your home. These types of loan can work for you whether your credit rating is good or poor (a good rating will usually mean you have made all the payments on time and you are handling your credit responsibly, whereas a poor rating could mean you have made late repayments or taken out a lot of credit in a short time.
The amount you can borrow, the repayment term and the interest rate you are offered will depend on your circumstances, including the amount of equity you have in your property. Equity is the percentage of your home that is owned outright by you, so it is the value of the property minus the remaining/outstanding mortgage owed on it.
For example, if you had a home worth £200,000 and your remaining mortgage was £100,000, you would have £100,000 worth of equity in your house, so depending on your circumstances, you could take out a second mortgage of up to £100,000.
You could borrow more with a second mortgage
Second mortgages are typically for amounts between £15,000 and £250,000. They are often called ‘second mortgages’ because they are separate from the mortgage on your home. This means any mortgage deal you have in place is not affected.
You can arrange different payment terms
The second mortgage is a loan that is not linked to your mortgage, so you have the flexibility to structure it the way you want.
How can I take out a second mortgage?
To qualify for a second mortgage you need to:
- Be a homeowner. Although you do not actually need to be living there, you do need to already own a home
- Pass an affordability test. The lender will need to check your credit history including your current mortgage payments, your expenses and your income to ensure you could afford the repayments on a second mortgage. The amount you could borrow and over what term will be influenced by this check
- Have equity in your home. A second mortgage enables you to borrow against the equity you have in your home – please see above for an example
Help ‘bridge’ a gap in finances
Bridging loans are designed to help if you have a gap in your finances that you need to fill. For example, if there is a time difference between buying a house and selling yours, a bridging loan could secure the new property whilst you sell the existing home.
Excellent for if you wish to ‘downsize’
Perhaps you wish to move to another property that is less expensive than the one you are currently living in. It may be that it has just become too big for your needs or you find the upkeep unmanageable. Let us say that you have found the perfect property to buy, but you want to act fast to secure it before someone else does. However, because you have not sold your existing home yet, you do not have the necessary funds to complete the purchase. A bridging loan could help you to buy the property whilst you sell your existing home.
Fixing a broken chain
All may seem to be going well with a chain of buyers and sellers, but suddenly, at the last moment, someone decides not to buy or sell after all (perhaps their finance fell through). This could put everyone’s plans back on hold for a considerable time. However, if someone took out a bridging loan, the buying and selling could generally progress after all.
Ideal for property developers
This type of loan can also help someone planning buy a property with the intention of renovating it and then quickly selling it on. It is a popular option with those buying at auction and needing time to put longer-term finances in place.
A valuable option for landlords
If you see an excellent opportunity to add to your property portfolio, but you need time to put get your finances together, a bridging loan may be the solution. It could be that you would find it difficult to take a mortgage out on the property as it is uninhabitable in its current state and therefore also viewed on as not possible to offer a mortgage on. Yet a bridging loan could enable you to purchase the property, develop it to state in which lenders may feel able to extend a mortgage or buy to let loan on it.
All the above examples illustrate how bridging loans can help by ‘bridging’ a relatively short-term gap in your finance.
You may be able to borrow very high amounts
As long as you can prove that the finance to repay the loan is pending, there is virtually no limit to the amount you can borrow with a bridging loan.
Bridging loans can be used by both businesses and individuals
A business could borrow millions to ease the process of a factory relocation, just as easily as an individual could borrow thousands to ensure they secure their dream property prior to their existing property’s sale going through.
Higher interest rates, shorter repayment periods
Because bridging loans are designed to bridge the gap of time before someone selling an asset and receiving the capital, they are not intended to have a long repayment period. Consequently, bridging loans tend to come with a relatively high APR to cover the lender in the event of the impending finances not materialising. Interest is added on a monthly basis to the total repayment amount of a loan.
Secured loans are also sometimes known as secured homeowner loans. See ‘What’s a second mortgage’ further above.
With a guarantor loan, both you and another person (the guarantor) take responsibility for repaying the outstanding debt. So, if you find that you become unable to make the repayments, the guarantor must make the repayments for you.
This type of loan is a useful solution for if you have a poor credit score or poor credit history that has left you struggling to get approval for a personal loan or has already led to lenders turning you down for a loan.
It is essential that you choose a guarantor who understands your situation and financial circumstances and appreciates that they will need to carry on the loan repayments for you if you cannot.
What is the guarantor’s role in this type of loan?
If the borrower keeps up with their loan repayments, apart from agreeing to be a guarantor and going through the application process with you, there is no need for the guarantor to have any further involvement.
The guarantor only becomes involved if the borrower misses payments or defaults on their loan. If the borrower misses one payment, the guarantor may be able to cover this and then the borrower could simply resume the repayments.
However, if the borrower defaults on the entire loan, the guarantor will become liable for the outstanding amount. This is because the guarantor is legally responsible for the money. They may then get into serious financial difficulties if they cannot cover the loan, and this will have a negative impact on their credit rating/history. It will also no doubt put a serious strain on the relationship between the borrower and the guarantor.
Who can be the guarantor for your loan?
Guarantor loans are unsecured (not secured on your property) so you do not need to be a homeowner to qualify for a guarantor loan.
But note that in most cases, your guarantor will usually need to be:
- A UK homeowner
- Over the age of 21
- Have enough equity in their property to cover the amount of the loan
- Anyone the borrower knows (family, friends or a close colleague)
Both you and the guarantor will need to provide information to the lender:
- Credit history
- Employment records/pay slips
- Bank statements
Whether or not the application for a guarantor loan is accepted will be based on the employment and financial status as well as the credit history of both the borrower and the guarantor.
An unsecured loan is also known as a personal loan.
A personal loan is a loan that a lender makes that is not secured against any asset such as your home. They are ideal if you want to borrow a specific amount of money and pay it back usually with a fixed amount each month over an pre-agreed period.
You can use a personal loan for pretty much any legal purpose subject to the lender’s approval, although some lenders will not provide unsecured loans for commercial use.
When you apply for a personal loan, you need to choose the amount you want to borrow and the period of time (the term) over which you want to repay it.
Regular monthly repayments are worked out to ensure that you pay back the full amount of capital, plus interest. Each individual repayment you make will contain an element of both the capital and the interest. You are guaranteed to repay the loan at the end of the term as long as you make all the payments in full and on time.
Personal loans do not tend to come with as much risk as secured second charge mortgage loans as your home is not in any way linked to it, so it cannot be repossessed if you default on the loan. However, your credit rating and credit rating might be negatively impacted if you don’t make your repayments. This in term will probably make it hard to be accepted for any loans or credit in the future.
Personal loans are often set-up for specific purposes, such as home improvement loans, car loans, wedding loans and holiday loans, but they are usually just a type of unsecured loan.
You can generally only be approved for personal loans if you have a good credit score
As long as you have a reasonable credit score you can apply for an unsecured loan. You do not have to be a homeowner to apply for an unsecured loan. No security is required as they’re usually designed for small loans. That is why they are called unsecured loans.
Unsecured loans are for smaller amounts than secured loans
These small loans are typically for amounts between £1,000 and £35,000 at Loan.co.uk.
Unsecured loans are repaid over a shorter period
Repayment terms for unsecured loans are usually between one and seven years at a fixed rate of interest. The shorter the term, the less overall interest you will pay. However, the monthly payments may be higher.
For developing land and property
A development loan is typically used by property developers to fund new, large scale building projects. Whether the project is a new development, a conversion of an existing property or a large building renovation, development loans help developers to get the finance they need to start and finish their projects. This may also include new residential housing projects, an office block construction or a large regeneration initiative.
The scale and scope of a building development project can influence the type of finance option available. The different types of building work can include:
1. Light redevelopment/refurbishment
Relatively unobtrusive work to the building, including light structural, internal work such as improvements to the walls, ceilings and floors. Funding tends to be short-term and the property can be redeveloped in a short period.
2. Heavy renovation
Heavy refurbishment includes major structural changes, such as building extensions or moving internal supporting walls. Finance options tend to include longer-term bridging finance (please see further below)
3. Ground-up development
Ground-up development usually involves everything from land purchase to completion. This type of development generally requires major architectural plans, a large team of builders and tradespeople. Finance will often need to be taken over many months or even years. The development finance can involve a series of releases of money until the project is completed.
Helps to expand your property portfolio
A buy to let loan is for buying a property with the intention of renting it out to tenants, rather than living in yourself.
They work differently to a residential mortgage. For example, you will usually be required to put together a larger deposit and typically pay a higher rate of interest than with a residential mortgage.
Landlords with a buy-to-let mortgage usually have their monthly mortgage repayments covered by the rent they receive from their tenants. However, it is important to allow for the fact that in some months there could be issues with collecting the rent and there may be expensive maintenance required.
Buy to let mortgages are usually on an interest only basis, so the capital debt (the amount you have borrowed) will only be repaid right at the end of the loan term. This contrasts with residential mortgages, as with these the monthly repayments usually include both the interest and part of the debt, so the loan and the interest is slowly paid back over the term of the mortgage.
Buy to let loan size
With a standard residential mortgage, the loan to value (LTV) can sometimes be up to 95%, so the deposit size could be just 5%. With a buy to let loan, most lenders will require at least a 25% deposit.
This means that the amount the lender will loan to you is less, so as to protect the lender in case you do not keep up with your loan repayments, often because of encounter issues with collecting the rent due.
The larger the deposit you can put down on the property, the lower your monthly loan repayments are likely to be.
A buy to let loan is often considered a higher risk by lenders than a regular mortgage. As a result, they tend to be more expensive with higher interest rates, plus you will usually need a bigger deposit.
Rental income usually taken into account
Lenders will carefully consider your rental income and weigh this up against your repayments to make sure you have a big enough ‘buffer’.
As with residential mortgages, there are various types of buy to let loans to choose from, including tracker mortgages, discounted variable mortgages and fixed rate mortgages.
Landlords need to remember that with an interest only loan, at the end of the mortgage they have to pay off the cost of the property purchase price at the end of the deal, as they will have only been paying the interest on the loan. Often landlords choose to do this by selling the rental property.
However, house prices need to have risen over the term of the loan or be at least the same as when the property was bought in order to be able to pay back what you owe. Of course, there will also be selling costs involved. If house prices have fallen at the time you decide to sell, you will need to be able to cover the shortfall.
Fund your business growth
Whether you are starting your business from scratch or looking to fund a significant expansion, businesses often require loans.
Businesses require an adequate amount of capital to fund start-up expenses or to pay for expansions. As such, companies take out business loans to gain the financial assistance they require.
The type of business loan most suitable for you can depend on what stage your business is currently at. Just like a person, a company has a credit history and credit score. The better they are, the easier it will be to receive funding.
Naturally, a new business will have little in the way of credit history, so most lenders will usually want to loan only small amounts to start small, or will need security, such as against property. Loans for business start-ups are typically available over terms of one to five years.
Businesses that are more mature usually have more options, as they will have had time to develop a credit history, trading accounts and can demonstrate their turnover.
The types of business loans
Here are some of the main sorts of loans that are available to businesses throughout the UK:
Loans for start-ups
Especially for businesses that have been trading for up to two years, these loans are usually for smaller amounts and are typically repaid over a time period of one to five years. As there will be little in the way of accounts to show the lender, a personal asset such as a property may be required.
Small business loans
Small business loans can be secured or unsecured and are often fixed interest over terms up to around 60 months (5 years). Many lenders will require a minimum annual turnover for the business to be eligible for this type of loan, but this will depend on the lender.
Short-term business loan
This type of loan is especially useful for businesses that have seasonal variations, for example, a company that might be busy over Christmas, but quiet over the summer months. A short-term loan is usually offered at higher rates than a five-year loan will be, as lenders need to make a reasonable profit.
Medium to long-term business loans
These loans are often used to fund larger projects for company growth, involving terms above five years and large amounts. The lender will need to examine your business plan and the security you are able to put up.
Options for interest rates and security
With a business loan you can choose whether the rate is fixed or variable. You can also take out a business loan that is secured against assets (such as stock, equipment or vehicles etc.) or unsecured, similar to a personal loan.