Another one of its flexibilities, a refinance can be used to combine two mortgages into one loan. This makes repaying the combined mortgage simplified and unified for borrowers, something to help them organize their mortgage affairs. What are the other benefits it holds for a homeowner like you? And given the chance, should you go for a mortgage consolidation refinance?
Of First and Second Mortgages
A first mortgage refers to the loan being used to buy a home. If taken together with the first mortgage, a second mortgage is used to avoid private mortgage insurance (when the debt to value ratio of the home is higher than 80%) or mitigate the effect of a higher interest rate when taking out a jumbo loan (which exceeds the conforming limit).
Second mortgages can also be taken out after a homeowner has built equity in his/her home. Home equity loans as they are called, borrow against the home equity to fund major expenses like home repairs, medical bills, college costs and pay off debts.
Home equity loans are called second mortgages because their repayment is secured on the home just like first mortgages. There are two types of second mortgages:
- Home equity loan. A lump-sum loan with a fixed interest rate.
- Home equity line of credit (HELOC). A line of revolving credit with an adjustable rate based on prime rate.
Refinancing to Combine Two Mortgages
Consolidating two mortgages through refinancing accomplishes any or some of these goals:
- Allows for a simplified repayment in the form of a single, lower-rate mortgage payment every month.
- Lowers rate of higher interest rate loans and thus lowering monthly payments in fixed-rate mortgages.
- Reduces the term of the loan and thus saves on interest payments, which may qualify for tax deductions.
- Eliminates the risk of paying for higher rates on HELOCs.
- Savings can offset refinancing costs for as long as you stay in the home for a long time.
To Combine Two Mortgages or Not?
Surely, mortgage consolidation awards many benefits to homeowners. But is it for you or applicable to your situation? Consider these scenarios to help you decide.
Equity. This often poses the greatest hurdle to refinancing to combine mortgages. Those with higher LTVs or owe more than their home’s worth may find it hard to refinance. Also, you still need to leave enough equity to pay back your second mortgage when you combine it with the first mortgage.
Timing. This refers to the amount of time that passed between taking your first mortgage and second mortgage. This “timing” can produce different refinancing outcomes in terms of rates and terms. Specifically:
- If you took out your first and second mortgage at the same time, your refinance transaction will be a rate-and-term refinance. Rate-and-term refi simply involves changing your loan rate and term and doesn’t involve taking out or reducing your equity. This makes the transaction less risky for the lender. In turn, the lender may give you a loan that is 90% of your home equity.
- If you took out your second mortgage after your first mortgage and most likely have taken out cash to pay off debts, the combination would be done under a cash-out refinance. Lenders deem a cash-out refi riskier and thus price this type of loan higher. Lenders may also limit the loan amount to 75% to 85% of your home equity. Nevertheless, you need to have sizeable equity to qualify for a cash-out refinance.
Credit. Lenders offer the best possible rates to refinancers with excellent credit. Be sure your credit has improved since your first mortgage application.
PMI. While you have used a second mortgage to remove any PMI; if you refinance and your LTV is higher than 80% of the home value, as appraised, you may have to pay for a PMI.
Prepayment. It might not be a good idea to combine two mortgages with a prepayment penalty, which can be an added cost when you refinance.
Combining two mortgages into a single loan may be a good idea but if you have doubts, it’s best to think things through. Don’t be afraid to seek advice from mortgage professionals. For sure, they can give out insights to help you form a wise decision.
Justin McHood is a managing partner at Suited Connector and has been recognized by national media outlets as a financial expert for more than a decade.