Using a Second Mortgage to Consolidate Debt?

Debt for many Americans is out of control and with all the turmoil in the mortgage markets, does it still make sense to consolidate debt using a second mortgage? The answer is: “Yes” for some people, “No” for some people, and “Maybe” for other people. So, which “people” are you? Let’s look…

But before determining whether this is a good financial strategy for you, be aware that you may not qualify for a second mortgage right now. One of the big casualties of the current liquidity crunch is second mortgage programs. Wall Street ain’t buying them right now, meaning most mortgage lenders have simply stopped offering them – period. Unless the lender plans on holding and servicing the loan itself (and some still do), it can’t afford to do this type of loan anymore.

Mortgages and the Liquidity Crunch

This “liquidity crunch” has taken most of the second mortgage lenders out the market. If it’s been awhile since you’ve shopped for a second, you’ll be shocked at how limited the offerings are. Lending guidelines are very tight, making it difficult for many “pretty good” borrowers to obtain an approval of any kind. And lenders aren’t allowed, under “predatory lending” laws to charge a higher interest rate to make these profitable – so you either qualify for a good interest rate loan with strict guidelines, or you don’t get one.

Right now, in order to obtain a second mortgage, you’ll need very high credit scores and lots of equity to play with. If you have a lot of credit card debt to consolidate – guess what suffers? You got it, your credit score! So, surprise, surprise, you may not qualify for a second mortgage loan now, even if you want one.

Loan amounts are restricted too. Finding a second mortgage that will allow your total mortgage loan-to-value (known as TLTV or CLTV) to go above 80% or 85% of what your home appraises for is very rare (2 years ago, it was easy to get 125% or more of your home’s value – even for so-so borrowers).

Finally, your loan’s chances are based on “current” values and has nothing to do with how much you paid for the home. Heard the news lately? Home values across the country aren’t doing so well – falling dramatically in many areas. Few areas of the country are holding steady or increasing in value right now – so lenders are going to be very cautious when it comes to putting themselves in second position with a loan secured by collateral that is losing value.

Using a Second Mortgage as Play Money

In my opinion, using your home’s equity as a personal discretionary income slush fund is really a bad idea. It always HAS been a bad idea, but during the past ten years of rapidly increasing home values, it was hard for many Americans to resist the lure of tapping into their new equity position to finance the lifestyle that they “deserved”. Right now, home values have stopped increasing – even declining significantly in many areas – but spending for many families has NOT declined accordingly.

It could be many years before we get back to “historical” rates of value increases and it is quite possible that your home could fall further in value before it increases again. I believe that real estate will continue to be an excellent investment when your thinking is long-term, but we’re in for a rough ride in the near-term. So, taking equity out of your home to pay off credit cards? Not a great plan for most people.

Using a Second Mortgage to Pay Off Debt - The Good and the Bad

In truth, some people CAN benefit financially by using a 2nd mortgage. If your credit card interest rates have gotten out of control and you can lower the rate significantly with a 2nd mortgage, that might allow you to take control of your budget. Credit card interest is not tax deductible and often 2nd mortgage interest IS tax deductible (consult your tax advisor). So, if the numbers work and you have the necessary equity to use, you may be an exception to my warning. But, if you have not figured out a way to live within your means and run the risk of running up more credit card debt, this 2nd mortgage is still a horrible idea.

What if your home’s value continues to drop and you find yourself in position where you need to sell (life happens sometimes). If, because you took out a 2nd mortgage, you now owe more on your home than you can sell it for, you’re stuck! The only way to sell in this case is to kick in the difference yourself out of your savings or you ask the lender to allow a “short sale”. Guess what? Short sales are starting to be viewed the same as a foreclosure, and if you find yourself in this position, it’ll be years and years before you’re allowed to finance a home again.

So, Should I Get a Second Mortgage?

For most people, the answer to the 2nd mortgage question is probably “No” (which is painful for me to say, because I make my living lending money, and telling you to avoid a new mortgage doesn’t help me feed my family). Get control of your credit card debt by cutting back, cutting up the cards (Don’t close your account – this will hurt your credit score – just stop using it), and consider meeting with a consumer credit counselor who can help you negotiate with your credit card lenders and develop a budget and recovery plan for you.

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