Which debt should I be repaying?

22 January 2013

Q

I have a friend with a Northern Rock Together mortgage, which comprises a mortgage and an unsecured loan. She is currently in negative equity.She may soon receive a lump sum that she could use to pay off some of the debt.My question is whether she should pay off some of the mortgage, or some of the unsecured loan?
From
LS, Leeds

A

The Together mortgage was available for as much as 125% of the property value, comprising 95% as a mortgage and up to 30% in the form of an unsecured loan.

Both elements were structured over the same term and both carried the same interest rate. Therefore, it shouldn't make any difference as to which is repaid in terms of cutting the mortgage bill and overall balance.

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As there are two elements to the borrowing, it is feasible to move the mortgage to another lender and leave the unsecured loan with Northern Rock. That will obviously depend on the proportion of the property value that the mortgage represents. If it remains at a very high loan to value (LTV) then there are unlikely to be many options, and they will come at a higher interest rate than is available to those with bigger deposits.

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Even if the mortgage element can be taken to a new lender to get a better rate, there is an implication for the interest rate on the unsecured loan that remains.

The original terms of the specific mortgage should be checked but, as an example, the literature for Together in 2007 indicates that the rate would increase to 8% above standard variable rate, so there's a trade-off to be factored in even if the lump sum payment enables the mortgage to be moved.