Refinancing and Second Mortgages

April 30, 1999 The ready availability of second mortgages both encourages and discourages refinancing, depending on the circumstances. Case 1: When the loan balance on a first mortgage is more than 80% of property value, it cannot be refinanced without paying for mortgage insurance. Under these circumstances, refinancing into a combination first and second may reduce the cost by enough to make the refinancing cost effective. Case 2: When there is already a second mortgage and the property has appreciated significantly in value, it may be cost effective to refinance into a single first mortgage. Case 3: When there is already a second mortgage but the property has not appreciated, the borrower may be unable to refinance the first mortgage because of the second. These points are illustrated in the letters (and my answers) below. "I have an 8.5% mortgage with 26 years to run, but because my house has depreciated in value I can't refinance the balance without paying for mortgage insurance. A broker has told me that I can borrow 80% of the balance at 7% and the other 20% on a second mortgage at 9.5%. Will this pay?" Probably it will, depending on the refinancing costs relative to the loan balance, and on how long you expect to be in your house. My spreadsheet program indicates that the break-even period for this deal -- how long you must stay with the new mortgage to cover the refinancing costs --is only a year if your costs are 1% of the balance, ranging up to 4 years for costs equal to 4% of the balance. "I purchased my house a year ago with a $100,000 first mortgage at 7% for 30 years, and a $40,000 second mortgage at 11% for 5 years. With house prices appreciating very rapidly in my neighborhood, I find that I can refinance the balance on both loans at 7%. Is there any reason why I shouldn't?" Unless you expect to move shortly, go for it. Your break-even period is about a year for refinance costs equal to $1400, rising to 5 years for costs of $5,600. "I have an 8% first mortgage with a balance of $122,000 and an 11% second for $28,000. My house is worth no more than $135,000. With first mortgage rates down to 6.5%, would I be able to refinance the first while leaving the second as it is?" Maybe, maybe not, depending entirely on the second mortgage lender. When you refinance the first mortgage, you pay off the old first mortgage, which results in the second mortgage automatically becoming a first mortgage. To avoid this, the second mortgage lender must agree in writing to subordinate his claim to a new first mortgage. Some second mortgage lenders will agree to do this, since it is no skin off their nose, but others refuse to do it and some will take the position that the only way they will cooperate is if they refinance the first mortgage.   Copyright Jack Guttentag 2002

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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