On Real Estate: Choosing between first mortgage refinance or a home equity loan requires homework

By Jim Hagerty
Staff Writer

Whether to refinance into a first mortgage or to obtain an equity loan can be a challenging decision. While both first and second mortgages come with their advantages, it’s never unwise to carefully decide which option will come with the best interest rate, lowest payment and be cheaper in the long run.

Keeping housing expenses manageable

It is important, before obtaining a first or second mortgage, to examine your current and future cash flow after a new loan is obtained. If a second mortgage comes into play, for many borrowers, it can come with the need for quick cash or direct access to home equity.

Cash from a home equity loan or line of credit can be convenient and seem like an inexpensive transaction. However, the payment on a second mortgage may add an unwanted expense to your outlay of monthly bills. It is wise to calculate how the payment on a second mortgage will affect your total housing obligations.

The total of a new housing payment, even a relatively small one, and your existing mortgage payment may not be a wise option, especially if current rates on first mortgages are low.

Shopping for first mortgage rates

It is sometimes possible, when first mortgage rates are low, to obtain a new, cash-out first mortgage and forgo the need for a home equity product. This can often mean that a new payment, even on a slightly bigger loan, could be lower than your current payment. It is wise to compare your current rate and payment with that of a new first mortgage.

If you can qualify for a low rate, the need to obtain a second mortgage doesn’t come into play unless a “zero-interest” junior mortgage can be obtained, and such mortgages are extremely rare.

Second mortgage terms

Some second mortgages are open-ended, with revolving lines of credit. This means interest is calculated much like a credit card. While home equity lines of credit (HELOCs) can come with small minimum payments, they may take many years to repay and cost you tens of thousands in finance charges and interest in the long run. It is wise to compare the costs of a second mortgage throughout the life of the financing before obtaining a loan. Even if you have to settle on a slightly higher monthly payment, a fixed-rate second is cheaper in the long run.

Bottom line

If you need immediate cash and you can obtain it by refinancing your first mortgage and avoid PMI, it’s generally a wise option. When rates are low, it’s usually possible to lower your rate and payment, obtain cash you need and reduce your repayment term. If you can’t improve the current rate on your first mortgage, a second mortgage is a suitable option. Most loan officers are able to compare costs of both choices and tailor a program to fit your needs.

From the Nov. 10-16, 2010 issue

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