To Consolidate 1st & 2nd, or Not

Dear Doctor Mortgage,

My first mortgage just reset, and I have a second that has a prepayment
penalty. This is causing my LTV to be more than 80%.
Should I refinance my first and leave the second?

I welcome any suggestions,

AAron


Dear Aaron,

Good question. But first, I want to explain the LTV reference for other readers. LTV means loan to value ratio, a formula in which the loan balance is compared to the purchase price or the value of the home. So a loan balance of $320,000 on a home valued at $400,000, for instance, would carry an LTV of 80%. And you’re right. Your LTV is high.

Providing your second lender is willing to issue a Subordination Agreement, which means they will still be in second position for payment after you’ve finished paying the first lender, you can refinance your first loan without touching the second.

As a general rule, and if the market price does not change too much, the second lender will usually agree to these terms as long as you don't take any cash out when refinancing the first loan.
The question of whether or not to consolidate the first and second loans or refinance the first only hinges on several factors such as the interest rate and loan amount of your current second loan
and the interest rate you will get from the new first loan.

If your current second loan is a 9% 30/30 (30-year-fixed loan) and you can get a new first with 6.5% 30/30 without Private Mortgage Insurance (PMI), which protects lenders from losing money in the case of a loan default or foreclosures on loans where 80% or more of the loan is financed, then it does not make sense to keep the second.

But if your first will increase by 0.5% when you consolidate the first and second loans, depending on the loan amounts and your home’s current market value, it might be better to leave that second loan untouched.

Also, don’t overlook the prepayment penalty. To calculate the penalty, you should establish how much you can save annually after refinancing the first and second and decide how many years it would take to offset any prepayment penalty. So, for example, if you are going to save $1,000 annually during the next five years by refinancing both loans but the prepayment penalty outweighs those savings, refinancing both first and second doesn’t make sense.