Once you have reached what you consider to be an acceptable level of equity in your home, you may consider converting some of that equity back into a liquid asset by taking out a second mortgage. The type of mortgage loan that you choose ― a home equity loan (HEL) which allows you to borrow a lump sum, or a home equity line of credit (HELOC) which establishes a credit resource that you can borrow from without necessarily borrowing the full amount ― may depend on your reasons for getting a second mortgage.
Advisable reasons to obtain a second mortgage include home improvements, education expenses, medical expenses, consolidating your debt, and acquiring a second home. It is not advisable to use a second mortgage as an alternate line of credit to cover day-to-day costs that you would normally put on a credit card, even if the interest rate on your second mortgage is more favorable than the rate offered by your credit card company. The reason is that credit card debt is an unsecured loan, where you are only putting up your credit rating to guarantee to the lender that you will not default. A second mortgage, by contrast, is a secured loan, and the collateral you are securing it with is your home. If you default on a second mortgage, the consequences could be foreclosure and eviction.
With this in mind, a second mortgage may make sound financial sense for your particular situation. If you are financing home improvements to increase your home’s value and are not sure what the final costs will be, you may want to take out a home equity line of credit (HELOC) which allows you to borrow a smaller amount and put it into repairs that, after an appraisal, might allow you to increase home equity and pay off your first mortgage sooner. If your son or daughter needs to pay college tuition and you don’t want the high interest rates associated with a private student loan, a lump-sum distribution in the form of a home equity loan (HEL) might help instead.
Interest on a second mortgage is tax-deductible in most cases, so if you used a second mortgage to pay-off other debts, you would be converting non-tax-deductible interest payments into payments that have a tax advantage. An alternative to getting a second mortgage is to refinance your first mortgage or take out a new mortgage on the second home, since the various costs and fees associated with a second mortgage are almost always less than the closing costs on a first mortgage. The interest on the second mortgage, however, is usually higher.