Should You Use a Second Mortgage to Consolidate Debt?

If you have high interest debt and own a home, you may be considering getting a second mortgage to consolidate what you owe. Using a home equity loan to refinance your payments and lower your interest costs sounds appealing, but is it the right move?

In this article, I’ll explain how second mortgage debt consolidation works, when it makes sense, and when it might lead to more financial stress.

What is A Second Mortgage?

A second mortgage is a loan secured against your home, behind your existing first mortgage. It can give you a lump sum of money that you can use to pay off credit card debt, payday loans, or unpaid bills. Unlike a home equity line of credit (HELOC), a second mortgage has a fixed term or amortization period and regular monthly payments. Because the lender takes on more risk, second mortgage rates are usually higher than first mortgage rates.

A second mortgage is different from refinancing your existing mortgage. With a second mortgage, you don’t have to break your first mortgage — which can save you money on prepayment penalties and legal fees. However, second mortgages usually come with higher interest rates than refinancing your existing mortgage, especially if your credit isn’t strong. The savings from avoiding penalties may be offset by the cost of borrowing at a higher rate.

Can You Consolidate Debt With a Second Mortgage?

Yes. If you have enough equity in your home, a second mortgage can allow you to pay off multiple high-interest debts and roll them into one lower monthly payment.

The amount of home equity you have determines how much you can borrow with a second mortgage. A second mortgage can allow you to access up to 90% of your home value for a debt consolidation mortgage.

Is Getting a Second Mortgage to Pay Off Debt a Good Idea?

While borrowing to pay down debt through a second mortgage can be risky, it can work well if:

• You have sufficient available equity to cover the amount you are asking to borrow.
• You have a solid employment history, stable income and acceptable debt-to-income ratio, generally below 43%, including any new financing.
• Your credit score is decent (typically in the low to mid- 600’s depending on the lender).
• You can afford your new mortgage payments.

The Risks of Using a Second Mortgage to Consolidate Debt

Using a second mortgage for debt consolidation isn’t always the right solution — even if you technically qualify. If the cost or risk outweighs the benefit, it may do more harm than good in the long run.

Here are some reasons why a second mortgage might not be the right choice for debt consolidation:

1. You risk your home: When you consolidate unsecured credit card debt into a second mortgage you convert unsecured debt into secured debt. If you miss payments, there is a risk your lender will take your house through a foreclosure or power of sale proceeding.
2. You may not actually save money: Second mortgages charge a higher interest rate than a first mortgage. If you get a mortgage with bad credit, this rate can be very high. I have seen people take on a second and even third mortgage with a rate of 29% or more. If your mortgage rate is high because you are a high credit risk, there may not be enough savings to make a long-term difference in your ability to get out of debt.
3. You can’t borrow enough: If you don’t have sufficient equity in your home to repay all your outstanding credit card debt (or whatever debts you want to put in your consolidation loan), then this is a non-starter. It generally does not make sense to consolidate some but not all your debts.
4. Financial conditions can change: A second mortgage can be a risky way to consolidate if it doesn’t help your long-term financial goals. If interest rates rise, or the housing market crashes and the market value of your home declines, or you lose your job, your financial situation may become even worse.
5. You may not solve the root problem – If your debt was caused by income loss or overspending, a second mortgage won’t fix the issue. Without budgeting changes, you could end up deeper in debt.

Should You Talk To Alternative or Subprime Lenders?

If you don’t qualify for a second mortgage through a bank or credit union, you might be tempted to turn to an alternate or “B” lender. These lenders are easier to qualify with but often charge much higher interest rates — sometimes between 10% and 29% — plus fees.

If a traditional lender turns you down for a second mortgage, they are doing so because they believe the risk of lending you more money is too high. They are concerned about your ability to make your future mortgage payments.

Your primary mortgage lender will often give you a reason why you are being denied a debt consolidation loan through your mortgage. It could be because you do not have enough equity to pay off your debt or because they are not convinced your income will be enough to make the payments, even if you have the equity.

Before accepting an offer from a subprime lender, it’s wise to explore all your options, including an interest-free consumer proposal.

When Not to Use a Second Mortgage

There are four situations when you should not get a second mortgage to pay off debt:

1. You have some equity in your house, but you can’t borrow enough to pay off all unsecured debts.
2. You don’t have the income or credit to qualify for a second mortgage.
3. The interest rate is so high you won’t be able to afford the monthly mortgage payment.
4. You are using a second mortgage to cover monthly expenses because your budget is not balanced, and consolidating other debt into a second mortgage won’t solve that.

There are inherent risks with a second mortgage, even if you qualify and can afford the payment today. Although you can get rid of credit card payments and overdue bill payments with a second mortgage, you now have two mortgages to pay. Stress test your decision based on what may happen in the future.

What If You Don’t Qualify For A Second Mortgage?

If you don’t qualify for a second mortgage or the payments are too high, you have other options. A consumer proposal is one alternative that allows you to consolidate your debts into one affordable, interest-free payment — without putting your home at risk.

A consumer proposal allows you to stay in your house and make a repayment plan with your creditors to pay back what you owe over up to five years.

There’s no interest on consumer proposal payments, unlike a second mortgage that could carry a higher interest rate, which means all your payments go towards paying down the principal of your debt.

How much of a debt settlement you may be able to offer, if any, depends on your income and home equity. It is possible to file a 100% consumer proposal instead of creating another mortgage to pay.

Where to Seek Advice

A second mortgage can be a useful tool for debt consolidation, but it’s not without risk. If you have high consumer debt balances and own a home with positive equity, I generally recommend talking with a mortgage broker first to see how expensive a second mortgage may be. If you don’t qualify or can’t afford the payments, it’s time to speak with a Licensed Insolvency Trustee about the benefits of filing a consumer proposal instead.

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1. Second Mortgage Home Equity Loan or Interest-Free Consumer Proposal?
2. Can’t Pay Your Mortgage? Mortgage Relief Options to Keep Your Home
3. Should I Get A Debt Consolidation Loan? Pros and Cons
4. Risks of Debt Consolidation Loans – The Hidden Traps
5. Does a Consumer Proposal Affect my House and Mortgage?