125 Percent Second Mortgage

A 125 percent second mortgage, a type of no equity loan, lets you borrow up to 125 percent of the value of your home, depending on the amount owed for the first mortgage. For example, if you buy a home worth $100,000 and owe $90,000 on it, you could borrow up to $35,000.

There are some benefits for this type of second mortgage. Most notably, the interest rate is usually lower than that fee charged on a credit card. Also, monthly payments are much lower. For this reason, many people consider 125 percent second mortgages as a means of debt consolidation. Doing so may considerably lower the total monthly expenses.

However, when crunching the numbers here, it’s important to look not only at the monthly benefit of lower payments, but also at the long-term scenario. The 125 percent second is typically calculated for a long period of time, of perhaps 15 to 25 years. Those credit cards, car payments, and other debts you are paying off are a lot shorter term. Even though your monthly payments are lower, the total amount paid in interest by the end of the term may be greater.

Another potential drawback of mortgaging your home for more than its value is that it makes it virtually impossible to sell the home until the total amount owed becomes less than the home’s value. That may take several years. In addition, the interest payments of the loan portion that exceeds the home’s value are not tax deductible.

There are, of course, circumstances where a 125 percent second mortgage may be a good idea. It may be a tool to get over a difficult situation and avoid more dire consequences such as bankruptcy. The total interest can still be reduced by making additional principal payments as it becomes possible.

For example, suppose you use a 125 percent second mortgage to pay off credit cards and car payments that total about $500 a month. The second mortgage gives you payments of only $250. If you pay as close to the original $500 a month towards your house as possible, much of the bottom-line added interest expense will be eliminated, and you will get into a positive equity situation in a shorter period of time, and will have made good use of the funds from the second mortgage.