When a borrower has two mortgages, the refinance decision is complicated, but my calculators make it simple.

Refinancing When You Have Two Mortgages
September 4, 2000, Reviewed June 30, 2007, Revised September 8, 2010

"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 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.

    3a Refinancing One Mortgage
    3b Refinancing Two Mortgages

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.
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