Falling out of love with your 2nd mortgage?

Grier Smith on 01 23, 2006

Those of you with variable home equity line of credit, do you ever find yourself thinking, “I’ve got two loans -the first mortgage has a great rate and the second is a variable home equity line of credit with a steadily climbing interest rate.” To make matters worse, Fed watchers speculate we’re likely to have at least 2 more increase before the Fed takes a break. Credit lines usually go up and down with the prime rate and as everyone knows the prime has been on the rise.

With that in mind, many folks are asking themselves, “How do I decide whether or not I should combine my first and second mortgage into one loan”?

There are many factors to consider, but a good place to start is to determine the blended average of your current 1st and 2nd loans. Thanks to a quick search on the internet and the informative Bankrate.com, I found this “easy to use” formula. Now, I’m not the kind of guy that considers a night at home crunching number a great way to relax. I do enough of it during my day job! My wife is not the least bit interested in crunching numbers. Not that she couldn’t do it if she wanted to, she just doesn’t want to! So if you fit into that category, call a Mortgage Professional, they can help you out.

If you want to crunch you own numbers, here is how I determined the blended average of a 1st and 2nd loan.

Dig out the current balance and interest rate of your 1st mortgage. Let’s say its $220,000 at 5.875%. Get the current balance and interest rate of the 2nd – let’s say its $40,000 at 7.25%. The first step is to add all the mortgage debt, which in this example is $260,000

Divide the amount of the 1st mortgage ($220,000) by the total debt ($260,000). The result is 0.846. This number represents the percentage of your 1st mortgage in relation to your total mortgage debt. Multiply that percentage by the rate: 0.846 times 5.875 equals 4.970

You’re in for more fun! Do the same with your 2nd. Divide the amount of your 2nd mortgage ($40,000) by the total debt ($260,000). The result is 0.154. Multiply that percentage by the rate of your second: 0.154 times 7.25% equals 1.117.

Finally, add those numbers together for your blended average: 4.970 plus 1.117 equals 6.087%.

If your blended is average is in line with today’s rates, your fine. If your blended average is higher then rates today (and you feel sure variable rates going even higher), you may want to consider refinancing, and rolling your 1st and 2nd together. As I mentioned above, there are other factors homeowners need to consider. How long will you be in the house? If you are planning to sell the home in the near future, the cost of the refinance would not make sense.

But if you keep a large balance on your 2nd, and you’re likely to be in your home for 5 or more years, a refi may make sense.

About the Author: Grier Smith

Pacific Crest Savings Bank Private Mortgage Banking 425.646.1334

One Response to “Falling out of love with your 2nd mortgage?”

  1. osman
    January 23, 2006 at 10:41 pm

    Hi Grier,

    Nice article. A couple of comments.

    Your first paragraph suggests that the Federal Reserve has been increasing the prime rate. For clarity, the Prime Rate is a market determined rate that commercial banks charge (usually corporate) customers. The Fed meanwhile controls the discount rate, a short term institutional lending rate for borrowing directly from the Fed.

    Second, and perhaps more important, a blended average interest rate won’t show the potential impact of rising rates on a client’s monthly payment. It may be more useful to model both mortgages against the index of the adjustable, up to the interest rate cape (if it has one).

    In the end, I’m not sure a lender is the most qualified to do this sort of analysis. A fee only personal financial advisor is probably better suited, but watch for those who only offer prepackaged solutions.

    Reply
    #1539

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