Raising funds can be a costly business

Published on Wednesday 16 November 2005 12:05

YOU need a significantly sized loan, most likely for purchasing a new car, making home improvements or for consolidating existing personal debt. Or perhaps there's a summer wedding to finance.

So, which is the more economical option for raising funds - a secured loan or a re-mortgage?

As always, circumstances need to be considered and numbers crunched. On the face of it, the low mortgage rates currently available suggest the choice is a "no-brainer" but the interest rate is not the only factor in the equation.

Do you have sufficient equity in your property? If a first-time buyer probably not; house prices and values have remained fairly static these past months.

On the other hand, you may have a flexible mortgage allowing you to top up your financial commitment. For instance, a house valued at 200,000 and a deal allowing you to borrow up to 80 per cent of this value will furnish a further 30,000 (at a competitive rate) if your existing mortgage is 130,000.

Or you could look for a cheaper mortgage. The market is at its most competitive for years, but fiscal excitement over a lower interest rate achieved by re-mortgaging can be easily dampened by the fees involved.

Although valuation fees are usually waived for re-mortgages, there's the cost of arrangement and the exit or redemption fee incurred in closing down the existing mortgage. Lately, lenders have got wise and are using such fees to partly compensate for their lower interest income.

Check every part of a mortgage's cost. Research shows arrangement fees have increased by an average 42 per cent since last year. A 700 charge is not uncommon.

Worse are the exit fees, viewed by many as a deliberate "milking" exercise. According to Moneyextra, over the past year 53 lenders have increased their exit fees, 23 of them by more than 100 per cent.

Paying 295 to exit and 700 to enter raises the stakes if you're seeking a re-mortgage deal.

In contrast, a secured loan can vary in duration from three years to 25 years, with amounts available ranging from 5000 up to 100,000. It is secured against the home - usually a borrower's most valuable collateral.

If there is an existing mortgage then the secured loan represents a "second charge", one of the reasons why the interest rate is around two percentage points more on the APR scale (reflecting the fact that your mortgage provider has first call on the home should you default and go bust).

Second charge secured loans are often granted quickly, provided you meet the borrowing criteria. The amount, term and APR will depend on your equity in the property, the lender's assessment of your ability to repay and any adverse credit circumstances.

If you are thinking about consolidating existing debt, you should consider very carefully what could happen if anything goes wrong. Your home is at risk of being repossessed if you default on repayment, whether for a mortgage or a secured loan, so financial protection against sickness or redundancy is essential.

Many lenders incorporate payment protection insurance (PPI) within the loan. In recent months there has been much disquiet over its "overpriced" nature and the Financial Services Authority is now scrutinising the market.

A report by Morgan Stanley estimates as much as 20 per cent of banks' profits comes from the sale of PPI policies alongside credit cards and personal loans. Such a policy can effectively push an APR of 7.9 per cent up to 23.6 per cent on a 10,000 loan! If unsure, always seek a second opinion from your independent financial adviser before proceeding.

Willie Ewen, AWD plc Edinburgh, www.awdplc.com

This does not constitute investment advice and you should seek independent financial advice if you are unsure as to the suitability of any investment for your circumstances. Past performance is not an indication of future performance. The value of investments may fall as well as rise and you might not get back the full amount invested.