The loans are a variation of the second mortgage, invented as an offshoot of government-insured home improvement loans in the early 1990's. But whereas those earlier loans were restricted to home improvement projects (which would generally increase the value of the property, thus securing the loan against the home in the long run), the 125% LTV loan has most often been used for debt consolidation.

Homeowners with solid credit ratings and burdensome credit card and installment debt (such as car loans) can use the cash provided by such a second mortgage to considerably reduce monthly payments. For example, the owners of a home with a fair market value of $100,000 and a mortgage of $90,000 could obtain a second loan for up to $35,000, raising the total debt on the home to $125,000 or 125% of its fair market value, and then using the $35,000 to consolidate other bills.

The average 125% LTV loan is for $30,000 to $50,000, which generally makes enough cash available to pay off credit cards and other installment debt, such as auto or student loans. Sometimes there is even cash "left over" for a borrower's personal use.

No-Equity Loans Are Non-Traditional in Many Ways
Unlike the home equity loans of the past, 125% LTV loans have been aggressively marketed to consumers. There have been television advertisements, which are quite uncommon in the world of mortgage lending, and homeowners in some areas could receive several mailers per week offering quick cash to consolidate bills.

The heavy advertising is because the loans are so profitable for the lenders if they are paid back. Their creators are also a new breed in the mortgage lending industry, typically young and entrepreneurial, running businesses that are a far cry from the historical bank or savings and loan.

Indeed, until two years ago, the market for these loans was dominated by small, niche lenders willing to take the risk of offering larger loans than a property's value could cover in case of foreclosure. But traditional mortgage companies are beginning to offer them in response to consumer demand.

Consumers with the Right Credentials Snap Up No-Equity Loans
Taking the huge volume of lending that has occurred recently, as an indication the loans are tremendously popular. With outstanding credit card debt alone at record levels, all signs suggest that many homeowners will continue to turn to no-equity loans for relief.

Of course, a 125% LTV loan is not an option for everybody. Although borrowers can have very little equity in their homes to qualify, and some lenders will tolerate a debt-to-income ratio of up to 55%, borrowers must still meet strict requirements for creditworthiness.

Whereas Fannie Mae and Freddie Mac, the corporations that set many of the nation's lending guidelines as dominant players in the secondary mortgage market, look for a FICO credit score of 620 or above as a guideline for offering a standard mortgage, consumers wishing to qualify for a 125% LTV loan will need a score of 650-700 or above. Scores that high are generally considered excellent, and are significantly higher than the average score, which is 620-650.

In addition, to qualify for a no-equity loan, borrowers also need good incomes, steady jobs, and, of course, the good payment histories required to get the high FICO scores. These loans are designed for people who have always had good credit-and have used it freely enough to build up considerable debt. The ideal customer for this loan, as the lenders see it, is someone who has high debt, but has always just been able to pay all the bills.

Drawbacks You Need to Know About
Whether you're considering a 125% LTV loan or have already taken one out, there are several aspects of the loans that you need to know about to make wise use of this new kind of borrowing.

The loans are very appealing to homeowners who are struggling with high debt bills because they offer an apparently easy way to reduce monthly payments and consolidate many bills into one single monthly payment. And, the advertisements point out, mortgage interest-unlike interest paid on other kinds of debt-is tax deductible.

The IRS, however, has announced that interest paid on any portion of the loan above the home's fair market value cannot be considered mortgage interest, and cannot be deducted at tax time. Thus, in our example of the $35,000 125% LTV loan on the $100,000 home with a $90,000 mortgage, only $10,000 of the second loan could be considered a mortgage with tax-deductible interest. The interest on the remaining $15,000 is essentially unsecured debt just like a credit card.

And that interest can be substantial. Although interest rates on no-equity loans are not as high as many credit cards, they are also much higher than a normal mortgage. This is because the lenders who market the loans as a home equity product in fact consider the debt unsecured just as the IRS does, and charge interest accordingly. (Debt that is secured by a home is less risky-the lender can foreclose and sell the home to make back its investment-and can therefore be offered more affordably.)

The interest rates on 125% LTV loans tend to range from 13% to 16%-in some cases more than double the rate for normal 30-year fixed mortgages, and significantly higher than more traditional home equity loans, which are secured by the borrower's home. In fact, for borrowers with the good credit necessary to get one of these loans, these interest rates may even be higher than those available on some credit cards!

The loans are expensive up front as well, with loan fees typically around 10%.

And remember: lower payments can actually increase the total cost of repaying your debt. When bills from a short-term installment debt such as an auto loan or revolving debt like a credit card are consolidated into a no-equity loan, the repayment period is extended to 20 years. This significantly longer time-to-repay means your payments can be smaller-but also that you can pay two to three times more interest across the life of the loan than you would have with the shorter term.

A second mortgage that exceeds the fair market value of your home also makes it very difficult for you to move any time in the near future. Just as some homeowners find themselves unable to sell in times of declining real estate values because they owe more than the home would capture on the market, homeowners with a 125% LTV loan are "upside down" on their home loans, and cannot sell unless they can bring the balance of the loan to settlement themselves.

Without Strict Self-Discipline, You Could Lose Your Home
The biggest drawback to these loans, however, lies entirely within the habits and circumstances of the borrowers themselves. While consolidating expensive credit card bills into one no-equity loan may be a very wise financial decision, the benefits of lower payments will be rapidly undone if the borrower continues to take on new debt.

Having a pocketful of credit cards with a suddenly zero balance can be very tempting. But having to make payments on a mortgage, a second "debt consolidation" loan, and new monthly credit card bills may be overwhelming-and now, your home is on the line. If you do run up new debt on top of a debt consolidation loan-or even if unforeseeable hard times hit-and you cannot make your payments on your loan, you could lose your home.

So it is in the best interest of homeowners to make educated, informed decisions about how to handle this popular lending trend.