Ask Dr. Don By Don Taylor, Ph.D., CFA • Bankrate.com

Mortgage consolidation

Dear Dr. Don,
Can you refinance your first mortgage and pay off your home equity loan to have just one lump payment instead of two?
Kelly Consolidate

Dear Kelly,
You can refinance and consolidate the loans, but writing one check instead of two isn't reason enough to refinance. It needs to make financial sense to go through these gyrations. Make sure that there's no prepayment penalty associated with either loan, and consider whether the loan-to-value (LTV) will be above 80 percent of the home's appraised value. A first mortgage for more than 80-percent LTV will require private mortgage insurance (PMI), reducing or eliminating the cost savings from consolidating the two loans.

Since home equity loans are second mortgages, the interest rate on a home equity loan should be higher than the rate you can currently borrow on a first mortgage. That means that there are interest savings on the home equity side from consolidating the two loans. Use this site's refinancing calculator to determine if it makes sense to refinance your current first mortgage. If it does, then you can realize interest savings on the first mortgage, as well.

When in doubt, have your mortgage lender demonstrate how much money you're saving by consolidating the two loans. You'll be paying them a fair amount of money in closing costs to arrange this refinancing, so it's not out of line to ask them to demonstrate to your satisfaction why it makes economic sense to complete the transaction.

HELOC vs. home equity loan

Dear Dr. Don,
I am still confused about what a home equity loan and a home equity line of credit is. Also, does a home equity line of credit have a variable rate?
Ruth Revolving

Dear Ruth,
A home equity line of credit (HELOC) has a variable rate, a revolving line of credit that you can borrow against, repay and then borrow again, and flexible monthly payments. A HELOC can be a convenient alternative to credit cards and is less expensive than a credit card because the loan is secured by your home, and the interest expense is often tax-deductible. However, payment in full at the end of the loan term can require a large balloon payment that can leave you scrambling to find a loan to pay off the HELOC.

A home equity loan has a fixed rate of interest, monthly payments that amortize the loan so that the loan balance is zero at the end of the loan term, and there is no flexibility associated with the loan amount. You borrow a set amount, repay it over a set period, and pay a set interest rate. Like the HELOC, the interest expense is often tax-deductible.

If you're looking for a less expensive way to finance revolving credit, a HELOC is your best choice. If you're looking to finance a big-ticket purchase and don't need revolving credit, then the home equity loan is the better choice. You can read more about choosing between the two types of loans in Bankrate's home equity basics.

-- Posted: April 23, 2001