Second Mortgages vs. Home Equity Loans: An Important Debate
I need $50,000 to refinance credit card debt. Is it better to refinance my existing mortgage (with a balance about $140,000) into a new $190,000 mortgage, or should I borrow the extra $50,000 with a home equity loan?
Every homeowner in need of extra cash faces this question.
Most borrowers with mortgages acquired a few years ago when rates were significantly lower fare better with a second mortgage than with a cash-out refinance. However, to know for sure, you must consider a host of factors, including:
* The interest rate and points you have to pay to refinance the first mortgage, compared with the same costs for a second mortgage.
* Any mortgage insurance requirement on the new first mortgage.
* The interest rate, mortgage insurance, and period remaining on the term of the existing first mortgage.
* The term you select on the new first relative to that on the new second.
* The amount of cash you need.
* Your income-tax bracket.
* The length of time you expect to remain in your home.
* The interest rate you can earn on savings.
Consider a mortgage calculator that computes all costs of both options over a future time period specified by the user. These tools also show a break-even interest rate on the second mortgage: the highest rate you can pay on the second and come out ahead of the refinance option.
The second mortgage is the less-costly option if it is available at an interest rate below the break-even rate.
Consider this case: You have a $140,000 first mortgage and you need $50,000. The average age of most refinanced mortgages is a few years, so we’re assuming you acquired yours two years ago, at 7 percent for 30 years, without mortgage insurance.
Let’s assume you are in the highest income tax bracket (39.6%) and can earn 5% on your investments. Your house is now worth $213,000. A new home loan for $190,000 plus settlement costs will require mortgage insurance. We’re assuming the insurance will continue during the entire five years you expect to remain in your home.
The new first mortgage would be for 30 years at 8.25% and one point. The second mortgage for $50,000 plus costs would be for 15 years at 11.5% and one point.
The break-even rate on the second mortgage is 18.25%, well above the market rate of 11.5% for the second. Over five years, the second would cost $11,361 less than mortgage refinancing the first.
It is evident that borrowers who acquired mortgages a few years ago at home loan rates significantly below the current market are likely to do better taking second mortgages than refinancing. However, older mortgages carrying higher rates can be a different story.
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SOURCE: MTGProfessor.com