Homeowners have options if they have a lot of unsecured debt, such as credit card debt. A viable option is to take out a second mortgage loan to consolidate debt or refinance revolving credit lines. This type of move has some great advantages that you should consider. Your home is an asset that generally will gain value over time as the market appreciates and you pay down your mortgage. Why not use that asset to pay off debt and to use for other projects and goals? Here are some reasons to consider a second mortgage for debt consolidation:
#1 Second Mortgages Have a High Limit
Generally, you can borrow a lot of money with a second mortgages. Most lenders will not even bother if it is less than $20,000. The reason that you can borrow more is that the debt is secured by the property, which is usually worth $100,000 or more. This means if you do not pay the loan, you lose your home, which is of course why you have to be 1001% certain that you will repay the loan. Generally, you can borrow up to 80% of the home's value, which gives you a lot of room to consolidate debt. There are a few lenders that will allow you to borrow more, but expect to pay much higher interest rates. These loans are riskier.
#2 Low Interest Rates
A huge advantage of a debt consolidation second mortgage is that the interest rate is low. Again, this is a secured debt, so the interest that you pay is probably going to be a lot lower than a credit card interest rate. Also, second mortgages tend to have even lower rates than other types of mortgages. It is hard to beat a debt consolidation deal with a rate as low as 3%! Try to get that on a credit card. The fact is that consolidating loans into a mortgage can low your debt burden if you are able to lock into a lower fixed interest rate for a term that you can afford.
#3 Major Tax Benefits
One of the miracles of home ownership in America is that most of the mortgage interest you pay is tax deductible. This is a particularly big deal in the early years of paying your mortgage. In the early years, a large amount of your payment is just interest on the debt. So, when it comes time to pay your taxes, you can actually write off that mortgage interest. This can reduce your taxable income by thousands of dollars and can take a nice chunk off of what you owe the government. When you take on a second mortgage and consolidate debt, you also can write off all of that interest that you are paying on the loan. You would never be able to do that with credit card debt.
#4 Second Mortgage Have Other Positive Uses
If you have money left after you consolidate your debts, you can use that money for whatever you like. Rather than buying a non-appreciating asset such as a car or electronics, you should think about either investing that money, or, put it into home improvements. By improving your home in certain ways, you can increase the value of your home. This could allow you to borrow more money in the future, or at least you will get a better price when you sell your home.
Considerations with Debt Consolidation Loans
While we advocate consolidating debt with a second mortgage, there are things to remember. First, taking out a loan on your home puts you at risk of foreclosure. If you do not pay the loan, you can lose your home. You simply have to be certain that you have the financial ability and stability to pay that loan off. Second, a junior mortgage does have closing costs that include credit checks, appraisal fees and origination fees. Even if the loan has no closing costs, it just means that the cost of the loan is being paid with a slightly higher interest rate.
Third, there are times when consolidating debt makes a lot of sense; you save big on interest and the interest is tax deductible, as we noted above. However, some people use the opportunity to free up their credit cards to go on another spending spree. This type of cycle rarely ends well. If you expect you will just be able to take out a bigger loan in the future, you may be disappointed. In the last market crash, property values plummeted, and people could no longer refinance or take out second mortgages to pay off debt. This caused many to lose their homes.
Taking out a debt consolidation second mortgage to refinance revolving debts can be a real-life saver as you can save yourself big on payment each month. As long as you use this consolidation loan as an opportunity to improve your finances, and not take on yet more debt, it is a wise financial move.
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