I did an entire quilt applique using flannels a couple of years ago. Not sure what needle I used, but I did use Steam a Seam Lite 2. I used the blanket stitch and didn't have any problems. I did use a new needle. It was a baby quilt. I recently saw the quilt after many, many uses and washes and it still looks GREAT! I was actually surprised. I worried and fretted over it the whole time I was making it, but apparently all worry was for not. The quilt is holding up very well. Oh, and I didn't have any problems with fraying along the edges.
Someone suggested using starch. I don't recommend this because the starch will keep the Steam a Seam from fusing properly to one or the other or both your applique piece or the background. This is my experience so just my opinion. Maybe others have had other experiences. Good luck!
I was going to attach a photo, but I can't find it, Oh Well.