Using a second mortgage for debt consolidation is one way of solving your debt problems. However, before opting to take this route you must consider the pros and cons. The pros might be obvious to you, but there are implications that might not be immediately obvious. Here are some of these.
Second Mortgage Subordination
When you take a second mortgage for any purpose and then pay off your first mortgage, the second mortgage automatically becomes the first. This means that if you have taken a second mortgage for debt consolidation, and repay the first while the second is still running, you cannot then take out another first mortgage.
However, the lender financing your second mortgage can agree to subordinate it to a new first mortgage. The latter then becomes your first mortgage and the former remains the second. Second mortgage subordination is not mandatory, and those that agree to it can charge whatever fees they believe appropriate. Technically, these can range from very low to extremely high.
Private Mortgage Insurance Issues
If you are paying private mortgage insurance (PMI), the insurance is legally terminated when the balance of your loan drops to 78% of the original. However, there is facility for you to request the lender to terminate at 80%. If you do so, the lender must terminate the PMI.
However, if you have a second mortgage, for debt consolidation or any other reason, the lender need not do this. You will then be paying a potentially costly PMI for an extra two years.
Keep an Eye on Interest Rates
When using a second mortgage for debt consolidation it is important to keep an eye on the interest rates. Some second mortgage rates are higher than the rates charged on many debts such as some credit cards. A second mortgage is really a secured loan, and is not subject to low rates.
So don’t think that you will be offered 5% – 6%. We are talking more in the region of 12% – 15% depending on the general lending rates for loans secured on property. There is little point in borrowing money on your home to pay a debt that is being charged at a lower interest rate!
By shopping around, you may find rates lower than your credit card rates. The rate you are charged will depend on your credit score. A FICO score of 700 will give you lower rates than a score of 600. The charges you have to pay upfront will also be lower with a higher credit score.
Second Mortgage for Debt Consolidation: Summary
There are pros and cons for using a second mortgage for debt consolidation. Make sure you are saving real money by doing this, and do not take out the loan just to extend the repayment period. A second mortgage should be repaid as quickly as possible, or it will limit your ability relocate and buy another property. This also means, of course, that if you fail to maintain your payments you could lose your home, just as with your original mortgage loan.