Can you use a second mortgage to pay off debt? So many MoneyNerd readers have asked this question so we thought it’s time to clear things up. This guide will explain how you can get a second mortgage to pay off debt as part of a debt consolidation process.
Keep reading this guide to uncover how the equity in your property could help to solve your debt nightmare.
What is a second mortgage exactly?
A second charge mortgage is when you take out a second mortgage on a property that already has an existing mortgage, i.e. a first mortgage. Because you now have two mortgages, you will need to pay back each mortgage separately, whether with the same lender or not. When you take out a second mortgage you receive a lump sum payment that is repaid over many months. Some people classify home equity loans as second charge mortgages.
The second mortgage is an additional debt attached to the property and secured against your home equity. Therefore, your second mortgage will be determined by how much home equity you have available and you can be forced to sell the property if you do not repay. You should only apply for a second mortgage through a lender that is authorised and regulated by the Financial Conduct Authority (FCA).
At this point, it’s good to recap what home equity really is. Home equity is the value of your home that you have already paid off, i.e. a proportion of the property you have without any debt attached. It can be expressed either as a value or as a percentage.
To calculate the equity in your home, you must subtract your remaining mortgage to pay from the property’s current market value.
How much equity is needed for a second mortgage?
Getting a second mortgage depends on your credit score and ability to repay. But above all else, you must have sufficient home equity in the first place to act as collateral for the second mortgage.
Lenders typically allow you to borrow up to 80% of your home equity within a second mortgage. This means having £100,000 home equity could get you a lump sum loan up to £80,000. They do not allow you to borrow against all of your home equity because this is riskier for them and for the homeowner. If the property value decreases, the homeowner could get themselves into negative equity.
As well as a maximum amount of equity in your home that you can borrow against, some lenders introduce a minimum amount. Your second charge mortgage may have to be of at least £10,000. And as you cannot borrow against all your home equity, this means you’ll need more home equity than this too.
Do you need an appraisal to get a second mortgage?
An appraisal is an official valuation of your property and is used to accurately work out your home equity. Because property prices can change over time, using the amount you paid for a property – even if recently – is not an adequate way of knowing how much it is currently worth.
You’ll probably need a property appraisal when applying for a second mortgage which may be covered by you, the lender or both. Sometimes an appraisal may not be requested, but it could be in your interest to still opt for one, especially if you think your property and therefore your home equity is being undervalued.
If you’re not planning on borrowing against much of your home equity, it’s less likely to be needed when you take out a second mortgage.
Can I get a second mortgage to pay off debt?
You can take out a second mortgage to pay off debt. Scores of homeowners decide to pay off single or multiple debts with the money they can borrow against their home equity. Doing so can merge your debts into one convenient place, making it easier to budget for your repayments. And it can help you pay a lower interest rate.
This is known as debt consolidation.
How debt consolidation works
Debt consolidation is the term used to move all your debts into one place so you only have to make one monthly payment, preferably with the same or lower interest to pay. It works by taking out new credit and using the money to pay off multiple other debts, such as a personal loan and credit cards.
There are different ways of achieving this. Some people use debt consolidation loans specifically offered for this purpose, others choose a DMP or to remortgage – and it is also possible with a second charge mortgage.
The second mortgage loan can be used to pay off creditors where you are paying higher interest rates compared to the interest you will need to pay on the second mortgage. However, you should also consider other loan fees and closing costs to ensure that it is a cost-effective decision.
What debts can you pay off with a second mortgage?
Using a second mortgage to pay debt is possible on any kind of personal debt. From credit card debts to personal loans and store cards, there isn’t a restriction on what type of debts you can pay back through the money raised from a second charge mortgage.
The pros and cons of using a second mortgage for debt consolidation
The benefits and disadvantages of using a second mortgage to pay off debt can be determined by personal circumstances. Therefore you should always consider your own situation when making credit and debt consolidation decisions.
Yet, here are some of the more generic pros and cons of using second mortgages for debt consolidation.
- Potential lower interest – the interest rate you will need to pay on your second mortgage can be much lower than the interest rates of your credit card and loan debts. Lenders typically offer lower rates when the individual is securing the credit agreement with an asset, such as home equity.
- Merges your debt – putting your debts into one location can make budgeting for the repayment easier than having to juggle multiple debt repayment dates throughout the month.
- Larger borrowing – your home equity could be significant enough to allow you to borrow a large amount, helping you to pay off many debts. This could mean consolidating a large number of debts more easily (if required).
- Avoid early repayment fees – because you add a new mortgage rather than remortgage, you are not subject to early repayment fees on the first one. This is not likely the case when you choose to remortgage for debt consolidation.
- You are putting your family home at risk – by consolidating debts into a second mortgage you are putting your property on the line. If you fail to repay a second mortgage debt then the property may have to be sold to repay. Although creditors of smaller debts can chase you to court if you don’t pay, they cannot force you to sell without a charging order. It’s more likely they will use bailiffs first and you won’t have to sell the property.
- Second mortgage fees – second mortgages may avoid early repayment charges but they may still come with additional fees and expenses. For example, at the end of the second charge mortgage, you could have to pay closing costs equating to hundreds or thousands of pounds.
- Accessibility – if you have multiple debts or arrears, there is a chance you could have a poor credit score. This may stop you from accessing more credit, including a second mortgage. You may prefer to search for bad credit debt consolidation loans in these instances.
Does a second mortgage hurt your credit?
Taking out a second mortgage will not necessarily harm your credit rating. However, failing to keep up with monthly payments will result in the lender recording defaults on your credit file, which will cause your credit score to decrease. Not paying back second mortgage payments in full and on time puts your home at risk.
When is a second mortgage not a good idea?
Getting a second mortgage to pay off debt would not be a good idea if it doesn’t place you in a more advantageous position. Merging debts together is not the only objective of using a second mortgage for debt consolidation. The second mortgage must not cause you to pay a higher interest rate in comparison to the interest payable on the debts you will consolidate.
Moreover, paying slightly less interest is not the only consideration. You also need to factor in additional costs and the risk you are adding to your home. Do you feel comfortable consolidating debts tied with your family home? Some people decide that a second mortgage to pay off debts is not worth it for this reason alone.
Should I take out a second mortgage to pay off debt?
If a second mortgage will help you streamline debt repayments and at the same time save you money, you should seriously consider using this debt consolidation method. Whether it is worthwhile or not will depend on the numbers. Uncovering what type of second mortgage deals you can get is not always easy because they are advertised with representative APR based on 51% of applicants only. What deal you’re offered may be different.
You may want to employ the help of money advice groups of commercial finance services to assist you in searching and comparing the market. However, these services also come at an upfront cost or you end up paying commission.
You should also consider alternative debt consolidation methods that may provide comparative rates and fees with less risk to your property. We discuss some of them towards the end of this guide.
Can I take out a mortgage to pay off another mortgage?
It is possible to take out a mortgage to pay off another mortgage. This is known as remortgaging and is usually done to secure more favourable repayment terms on a new deal.
Remortgaging works by switching your first mortgage for another mortgage, meaning you still only have one mortgage to pay back – unlike when taking out a second mortgage. This is completed by searching for a mortgage lender that is willing to lend you the money that clears the debt on your first mortgage.
Remortgaging for debt consolidation
An alternative possibility is to remortgage to pay off debt. Instead of remortgaging to just pay off the first mortgage with an existing lender, you ask the new lender for a greater amount of money which is then used to pay off other debts, such as a credit card or loan debt.
For example, if you have an existing balance of £100,000 on your first mortgage, you could remortgage with a £120,000 new mortgage, giving you an additional £20,000 (minus fees) to pay off debts.
The drawback of remortgaging for debt consolidation is that you may be subject to an early repayment charge on the first mortgage. However, a second mortgage may cause you to incur additional fees as well, such as more closing costs to pay. You’ll need to weigh these up when considering remortgaging or a second mortgage to pay off debt.
Other debt consolidation options
If you’re not comfortable using equity as collateral within a debt consolidation method, you may want to use one of the alternative methods considered less risky. These are:
- Debt consolidation loans – you can actually get unsecured and secured personal loans for the purposes of debt consolidation. And some of them are advertised for people with bad credit.
- Balance transfer credit cards – a credit card with 0% interest for so many months or years. You simply transfer other credit card debts to this card and pay it off without any interest. Make sure you’re aware of the interest rate after the 0% period.
- Debt Management Plans – although not technically debt consolidation, this debt solution will mean only having to pay one monthly payment split between creditors – and you could wipe all interest payable in the process.
A UK debt charity can help you understand all types of debt consolidation and even support you in choosing the most relevant one for you. Their services are free and 100% confidential.
More guides on taking out a second mortgage to pay off debt
Bags more information on debt consolidation and using a second mortgage to pay off debt is available through MoneyNerd. We’ve published an array of articles and guides discussing these topics from different angles, answering your frequently asked questions in the process. Read them for yourself for free at any time by heading back to our website and blog!