When the conditions are right, the no equity second mortgage is a powerful option for homeowners.

In 1994, the action film No Contest was pitched to the movie-going public with the tagline, "No rules. No mercy. No escape." Unfortunately, the edgy tagline fell on deaf ears, and the film was almost universally regarded as a flop. Perhaps the writers should have incorporated some practical real estate matters into the script; then the film could have been marketed with: "No rules. No mercy. No equity."

No equity second mortgages are often misunderstood. The name implies that it's a mortgage offered to homeowners who don't have any equity in their property, but that's not exactly true. Here's why: lenders require that you have some equity to qualify for the no equity second mortgage. But they'll allow you to borrow against 100 percent or more of that equity, which would leave you with no equity after that second mortgage funds.

A winning home equity formula

To demonstrate, let's assume that you recently purchased your home for $400,000. You made a 20 percent down payment on the home, and financed the remaining 80 percent, or $320,000. Shortly after the purchase, you discover that an adult child and her family need to come home to live with you. As a result, you decide to remodel and add two more bedrooms.

Since you put 20 percent down when you bought the home, you have $80,000 worth of home equity. Unfortunately, the conventional second mortgage limits your borrowing power to 80 percent of your home's value. Since you already owe that much on your first mortgage, you wouldn't be able to borrow more. A no equity second mortgage, however, would allow you to borrow 100 percent (and sometimes more) of your home's value-but once you borrow that $80,000 for your remodel, your home equity value is reduced to zero.

You can use a no equity second mortgage to finance almost anything, including a home remodel, education expenses, or debt consolidation.

Read fine print

No equity second mortgages generally have fixed interest rates and fixed amortization schedules. In other words, you'll know what your monthly payment is going to be and when your loan will be paid off. The interest rate will be higher than that of a conventional second mortgage, but the interest should be tax-deductible.

Tapping out your home equity has its risks. Selling the home may be problematic. If its value stays the same or increases modestly, a sale might raise enough to pay off the mortgages, but you'd still have to cover your agent's commission and other sale-related fees. If its value decreases, you'd have to pull cash out of your pocket just to pay off the debt.

These dangers may not be as thrilling as action-movie bad guys carrying heavy artillery, but they certainly are more relevant. Make your decisions carefully, and try to leave the unnecessary dr

Published on September 1, 2008