Refinancing a piggyback mortgage loan

Posted on February 13 By MLP Blog

Dear Dr. Don,
I recently learned that my credit union is offering a 100 percent mortgage available at a rate of 7 percent. I currently have an 80/20 mortgage on my home. The 80 percent first mortgage is a 30-year fixed rate at 6.375 percent and the 20 percent second mortgage is a home equity line of credit, at prime plus 2 percent. My question is, does it make sense to take out the one fixed-rate mortgage as opposed to the two I currently have?

My home is worth approximately $327,000. The loan balance on the first mortgage is $253,000 and the loan balance on the line of credit is $64,800. I’ve been in the home for two years, and expect to remain in the home for at least two more years.
Thanks for your help.
Tom Tinkerer

Dear Tom,
I recommend that you stay with your current loans, for a couple of reasons. First, you aren’t sure that you’ll be in the house for very long. Refinancing a first mortgage is an expensive proposition. According to Bankrate’s 2006 national survey of closing costs, you should expect to pay somewhere around $3,000 to close that loan.

Second, your existing first mortgage is ? of a percent less than the credit union’s mortgage loan rate. Saving ? of a percent on a $253,000 loan balance doesn’t quite trump saving 3¼ percent on a $64,800 loan, but my guesstimate (below) has only a $525 difference in interest expense in the first year of the refinancing. If you pay $3,000 to refinance, then it’ll take about 6 years to recoup that cost. You’re not sure how long you’ll be in the house, so it’s hard to justify it on that basis.

  Current rates New rate Difference Estimated change in the first year’s interest expense
Home value:
$ 327,000
First mortgage:
$ 253,000
6.375% 7.000% -0.625% $ (1,581.25)
Second mortgage:
$ 64,800
10.250% 7.000% 3.250% $ 2,106.00
        $ 524.75

As of February 2007, prime plus 2 percent equals 10 ¼ percent. That’s expensive for a line of credit, but it’s priced to reflect the lender’s risk when a homeowner has minimal equity in the property. By your estimate you have 3 percent equity in the home. I’ll be the first to tell you that I don’t know where interest rates are headed, but the expectation is that the prime rate is at or near its high for this interest rate cycle and its next move is expected to be lower.

Instead of refinancing both loans, focus on making additional principal payments on the line of credit to get to a point where you can refinance that loan at a rate closer to prime. Closing costs on a new line of credit are measured in hundreds not thousands of dollars. That presumes that there’s no prepayment penalty on the line of credit. Check with your lender if you’re not sure about a prepayment penalty.

Found here.

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