2nd Mortgages and Debt Consolidation

People frequesntly ask me if they should take out a 2nd mortgage to consolidate their debt and lower their monthly payment. The typical question will go something like this:

"I owe $40,000 on 5 credit cards with interet rates of 6 to 15%. The monthly payments are quite high. I can get a second mortgage at 9% to consolidate the debts and lower my monthly payments. Should I do it?"


My answer is a very firm "Maybe." Here's why:

Don't Pay Lower Rates With Higher Rates

Some of the credit cards that will be consolidated with the second mortgage have a lower interest rate than the mortgage. This will lead to a higher expense in the long run. If you do consolidate you should exclude the debts that have a lower interest rate.

Second Mortgages Reduce Your Flexibility

A second mortgage may cause the total debt on the property to exceed the value of the home. If you wish to sell the home and move in the future you will have to come up with the cash to pay off the mortgages out of your pocket.

Also, if future interest rates become attractive you may be unable to refinance. When you pay off the first mortgage the seond mortgage becomes the new first mortgage. You will only be able to get a new first mortgage if the current second mortgage lender agrees to move back into second position. Some lenders will readily do this for a fee, others may not do it at all.

Second Mortgages May Be Expensive

Typically there are closing costs or upfront fees when applying for second mortgages. Don't let the thought that you are not paying anything out of pocket make you think that there aren't any fees. Look at the bills you are paying off and the amount of your loan. You may find that the loan amount is $45,000 to pay off that $40,000 in credit cards. No cash out of pocket doesn't mean that you are not paying anything.

Danger of Overextending Yourself Again

I frequesntly see people pay off their credit cards with mortgages and then a few years later they have their credit cards maxxed out again. Since they've paid their balance down to zero they have all that extra credit available again. They open credit lines with no balance may even lead them to qualifying for more credit cards. Shortly after consolidating their debt they owe $40,000 in credit card debt again (or more). If you do use a second mortgage to consolidate credit card debt you need to be careful to avoid falling back into this trap.