When it comes to securing loans, the terms ‘first charge’ and ‘second charge’ are often thrown around.
But did you know there’s another type of charge that can be used to secure a loan?
It’s called an ‘equitable charge’, and it can be a viable option for borrowers under certain circumstances. In this article, we’ll explore what an equitable charge is, when it might be needed, and how it compares to legal charges.
What is an Equitable Charge?
An equitable charge is a type of security interest that can be used to ‘secure’ a loan against a house, investment property or commercial building.
It’s often used when a full legal charge isn’t possible or has been refused by the first charge lender. Unlike a legal charge, an equitable charge doesn’t give the lender the automatic right to sell the property if the borrower defaults on the loan.
Instead, the lender would need to go to court to obtain an order for sale.
What is a first charge?
A first charge, refers to the primary legal claim over a property. This is typically the mortgage used to buy the property itself (or a remortgage).
When a property is used as security for a loan, such as a mortgage, the lender takes a legal ‘charge’ over the property, which is registered with Land Registry. This formal charge gives the lender the right to take possession and sell the property if the borrower fails to repay the loan as agreed.
Any subsequent loans secured against the property, such as a second mortgage or a secured loan, would typically be ‘second charge‘ or ‘third charge’, and so on. These lenders would only receive repayment from the sale of the property after the first charge has been fully repaid.
What is a second charge?
A second charge, often referred to as a second mortgage, is a loan taken out against a property in addition to the main mortgage.
In the context of property loans, the ‘charge’ refers to the order in which any loans secured against the property will be repaid if the borrower defaults and the property is sold.
The first charge has priority and will be repaid first from the proceeds of the sale. The second charge will be repaid after the first charge has been settled, and so on.
Taking out a second charge increases the risk of losing your home if you can’t keep up with the repayments, as the lender has the right to sell the property to reclaim the debt.
When Would an Equitable Charge be Needed?
Equitable charges typically come into play when an attempt to create a legal charge has been unsuccessful, or when it’s not possible to obtain a legal charge.
This could be due to a variety of reasons, such as the first charge lender refusing to consent to a second legal charge.
In such cases, some lenders may opt for an equitable charge as it doesn’t require permission from the main lender, in fact you don’t even need to notify them.
This can be particularly useful for borrowers who want to utilise the equity in their property when a conventional second charge loan isn’t an option.
Why would a first charge lender refuse to give consent?
A main lender might refuse to give consent for a second legal charge for several reasons:
Risk Management: The first charge lender has the primary claim on the property in the event of a default. If a second legal charge is added, it could potentially complicate the process of recovering their funds, especially if the property’s value has decreased or if the total debt exceeds the property’s value.
Breach of Agreement: Some mortgage agreements include clauses that prohibit the borrower from adding additional charges to the property without the lender’s consent. This is to protect the lender’s interests and ensure they can recover their funds in the event of a default.
Financial Health of the Borrower: If the borrower is seeking to add a second charge, it might indicate financial distress or a higher risk of default. To mitigate this risk, the first charge lender might refuse to consent to a second charge.
There are a number of lenders who’s policy is not to approve any requests for second charges.
Not on the High Street!
The high street lenders can’t help every mortgage customer and they prefer the simple, low-risk ones.
If your situation is a bit different or needs a more personalised solution then our brokers can help.
Expert advice, for all situations.
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Let to Buy
Let to buy combines a buy to let remortgage with a residential mortgage. Allowing you to move house while keeping your current home.
Example of an Equitable Charge
Let’s say you own an investment property with a mortgage (the first charge) and you want to borrow some more money with a second secured loan.
The secured loan lender will write to the first lender, explain that you have applied for a loan, and requests permission for them to register a second charge on the property.
However, the main lender refuses to consent to a second legal charge on the property.
In this case, the new lender could opt to secure the loan with an equitable charge instead. This allows you to access additional funding without breaching the terms of your first mortgage.
Equitable Charges vs Legal Charges
The main difference between equitable and legal charges lies in the rights they confer to the lender.
A legal charge gives the lender an actual legal interest in the property, including the power of sale if the borrower defaults on the loan. On the other hand, an equitable charge doesn’t give the lender an automatic right of sale.
Instead, the lender would need to obtain a court order to sell the property.
Another key difference is that a legal charge requires the consent of any existing legal charge holders, while an equitable charge does not. This makes equitable charges a more flexible option in situations where obtaining a legal charge isn’t possible.
Equitable charges are still included in the Land Registry records, and will be added to the property ‘Charges Register’ using an RX1 application.
Equitable Charge Loans
Equitable charge loans can be a useful tool for borrowers who are unable to obtain a second charge mortgage in the normal way.
Loans are rarely available on your main home.
Most lenders prefer investment properties such as buy to let, holiday let, second homes, HMO, commercial and semi-commercial.
Short term bridging options are also another option. Maximum LTV’s tend to be around 65-75% (inc the main mortgage).
Not having a full legal charge does create an extra risk for the second lender. Because of this, they are likely to charge a higher rate of interest, and there won’t be as many lenders to choose from.
Even with the higher cost, they can provide convenient access to your equity, despite an uncooperative first lender.
Remember, while an equitable charge doesn’t give the lender an automatic right of sale, your property could still be at risk if you fail to keep up with the repayments. So, always ensure you fully understand the terms of any loan before you sign on the dotted line.
Ready to explore your options?
If you’re just about to start a new mortgage journey and could use the guiding hand of a professional, don’t hesitate to reach out to a reputable mortgage broker.
An independent mortgage broker can access over 100 lenders on your behalf. They will make the process smoother and more profitable than going it alone.
Keep reading, keep asking questions. The more you know, the better decisions you can make.
