Refinancing With a Second Mortgage:

by Bill Tannebring

Should I Refinance My Credit Card Debt with a Mortgage or an Unsecured Loan?

You see the TV commercials all the time: "Get a second mortgage," "Reduce your monthly payments," "Save money, get control of your debts." That's the pitch for second mortgages that allow you to borrow up to 125% of the value of your home. And as more people stuggle with credit card debt, they're wondering if a second mortgage could be the answer to their problems.

Years ago, taking out a second mortgage was considered an act of financial desperation, a way to avoid bankruptcy, a last resort. Today, however, homeowners regularly use home equity rather than debt consolidation loans to pay off credit card debt, pay tuition expenses and even take vacations. Former Fed Chief Alan Greenspan recently noted, "Home mortgage debt is thus the final source of funding for some consumer outlays originally financed by extensions of credit card and other consumer debt."

One reason for this is 1986 Tax Reform Act, which eliminated the tax deduction for interest on credit cards, car loans and most other consumer borrowing. And with the interest expense on home equity loans being one of the few remaining tax shelters left, many people now use tax-deductible home equity loans to purchase cars rather than non-deductible auto loans. If you they handle the monthly payments, there's nothing necessarily wrong with that. Actually, these loans look quite appealing. First, the interest rate charged is lower than on a credit card account. And rates have trended upward on credit cards. Even with good credit it's not unusual to be paying 15% or more on your credit card balance. Another attraction for borrowers is that the second mortgage comes with a lower monthly payment and can run 15 to 30 years. So people are only repaying a little bit of the principal each month. It's not unusual for someone who has credit card balances to reduce their monthly payment by one third if they transfer to a second mortgage. And besides being easier to get than unsecured loans, potential borrowers are reminded that some or all of the interest expense could be deductible from their federal income taxes. Well let's examine this a bit further. First, most companies that issue second mortgages offer adjustable rate mortgages of fixed rate mortgages. One company offers a rate of 12.25% but to get that rate you need to add 10% to the amount borrowed. If you want a lower rate, you'll pay even more.

Take this example; suppose five years ago you bought a home for $100,000. You put down 10% and took an 8% mortgage. We'll further assume that the home has appreciated and is now worth $110,000. But lately you've been running up a few credit card debts that total about $30,000. So what happens if you use a 125% second mortgage to consolidate those debts?

First, it will cost you $3,000 to borrow $30,000 and if you add the $33,000 in new debt to the balance on your first mortgage, you now owe $118,500 on a home that's worth $110,000. But that's not much more than the house is worth. On the plus side, you have reduced your payments. Depending on how much interest you're paying, you could be saving $250 each month in minimum payments.

But here's the biggest problem, you're stuck in your home! Forget about moving or refinancing for lower rates. Even assuming that the house appreciates 3% each year, if you continue to make the minimum payments on both mortgages it'll be 2 years before you owe less than the house is worth.

And selling it will be difficult. You'll need to make payments for at least four years to be able to sell it and pay the realtor a 6% commission. If you'd like to realize a 10% down payment for your next house you can plan on making those payments for 6 years before you put your house on the market. So, you're stuck in your home. Even if the house appreciates 3% each year, if you continue to make the minimum payments on both mortgages it'll be 2 years before you owe less than the house is worth.

And that's if home prices go up. There's no guarantee of that. There have been many times when real estate prices slumped for a few years. In that case you could be stuck in your house forever. Next, let's look at the amount of interest that you'll pay. Yes, the credit cards do carry a higher rate but because you pay them off more quickly you only end up paying about half as much in interest expense. On a loan this size you could write checks for an additional $10,000 to the mortgage company over the life of the loan. Another risk of home equity loans is the threat of foreclosure. When you take out a car loan, if you don't make your car payments, the lender will repossess your car. But with a home equity loan, if you don't make your loan payments the lender can foreclose and take your home!

So with those warning, second mortgages work best if three conditions are met. First, be sure the second mortgage doesn't come with a large origination fee. Second plan on paying off the second mortgage as quickly as possible. If you pay just the required amount each month you'll be giving away a lot of money in interest over the years. Thirdly, your goal should be to pay off the entire account balance each month. Consider anything less to be a failure. Letting your account balances to creep up again is the first step to financial disaster.

Home equity loans can be a handy financial tool if used wisely. Just make sure you have the financial resources to make the payments, and be aware of the consequences if you don't. And don't fall into the trap of thinking of your home equity as just another credit card. You'll surely continue to see television ads encouraging you to consolidate your loans into a second mortgage and they'll make it sound easy and safe. But be a smart consumer and consider all the consequences before you sign make the deal.

About the Author

Bill is an experienced free-lance writer who produces real estate and mortgage related new articles about refinance, equity loans and 2nd mortgages. You can read more mortgage related loan articles online at or please visit http://www.bdnationwidemortgage.com/

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Refinancing With a Second Mortgage:

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