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September 4, 2000
"I have an
8.75% first mortgage with a balance of $151,000, and a 12% second mortgage with
a balance of $37,300. The second
mortgage brought our total mortgage debt above the value of the property at that
time, which is why the rate is so high. Our house has since appreciated
substantially in value, and I�m sure I can profit by refinancing.
My question is, should I refinance the second only or should I refinance
both, and if I refinance both should I take out two new mortgages or should I
consolidate the first and second into a new first?
It is all too confusing.�
It is
confusing. The best choice depends
on a number of factors including:
Rates and
points available on new loans: Critically
important are the terms of new loans to refinance, relative to the terms on the
existing loans. This will depend on
what has happened to mortgage interest rates, the value of your property, and
your credit rating since you signed for the original loans.
When you have two
mortgages, you must obtain price quotes on a new first for the amount of the
balance on the existing first, and on a new second for the amount of the balance
on the existing second. You
also need a quote on a new first for the amount of the balance on both existing
loans.
How long you
expect to be in your house: Refinancing typically involves immediate costs to obtain future benefits -- the longer you
have the mortgages, the larger the refinancing benefit.
Current value
of your house: Appreciation in
the value of your house may make it possible to refinance the first mortgage
without purchasing mortgage insurance. If
large enough, appreciation could allow you to roll both loans into one without
paying mortgage insurance.
Remaining term
on existing loans: The shorter
the remaining term on your existing loans, the smaller the refinancing benefit.
With a shorter remaining term, you pay off the existing loan faster,
which reduces the cost of the higher rate on that loan.
Term on new
loans: The shorter the term on
your new loan(s), the larger the benefit from refinancing.
While shorter terms increase the cost of monthly payments, this is more
than offset by the more rapid pay down of the loan balance.
Your income
tax bracket: The tax savings on
interest payments usually reduce the net benefits of refinancing. The higher
your tax bracket, the smaller the benefit of an interest rate reduction on a new
mortgage. However, if the
remaining term on the existing loan is short, expect the reverse -- the
refinance benefit can be larger for a high tax bracket borrower.
Complexities such as these make refinancing two mortgages perplexing.
Fortunately, it
is now possible to determine which of your three alternatives provides the
greatest benefit without mastering all the complexities.
Two new refinance calculators I developed with Chuck Freedenberg of
DecisionAide Analytics compare the cost of refinancing against the cost of
retaining the existing mortgage or mortgages over a future time horizon.
To access them, click on "Calculators" in the margin.
One calculator
assumes you refinance only one mortgage. The
second assumes you refinance two mortgages, with either one or two new
mortgages. The calculators also
show the breakeven period, which is how long you must stay with the new loans to
just break even.
Based on your
information, the calculators reveal that over your 6-year time horizon, you
would save $2319 by refinancing the 12% second mortgage into a new 30-year
second at 9.5% with one point. You
would save $2392 by refinancing the 8.75% first mortgage into a new 8.125% first
with one point. Total savings over 6 years from refinancing both mortgages would
be $4711.
If you could
consolidate both of the existing loans into a single new first mortgage at
8.125% and one point, the savings over 6 years would be even greater -- $7187.
However, the best quote you could get in today�s market on this
larger first mortgage was 8.50% with one point.
At this higher rate, the
savings from consolidating the mortgage fall to $3788, which is less than the
savings from refinancing into two mortgages.
Every case is
different but the calculators will handle them all.
Copyright Jack
Guttentag 2002
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