mortgage

Consolidate 2 mortgages for lower rate?

Don TaylorQuestionDear Dr. Don,
We recently decided to refinance our mortgage. We went to the lender that had our current mortgage. In the end, we found out that they were not refinancing just our mortgage but wanted to refinance our mortgage and home equity loan into a home equity loan. We would receive a lower rate, save about $1,200 per month and have a 30-year mortgage rather than the 20 years left on our existing mortgage.

Our questions:

  1. Do home equity loans and mortgage loans have the same tax advantages?
  2. What would happen to the mortgage exemption if you no longer have a first mortgage, but instead only have a home equity loan?
  3. We are in our mid-50s. In the unforeseeable event we have problems paying our house payment, is there more protection with a conventional mortgage loan rather than a home equity loan?
  4. What are the advantages and disadvantages that you see with what this company is proposing to do when our original reason was simply to refinance our home to take advantage of a lower rate?

I am very confused and concerned and do not want to make a decision that in the long run will cost me if some misfortune happens and I need time to get my finances together.
-- Nelvia

AnswerDear Nelvia,
The lender on your existing home equity loan would have to agree to a refinancing of your first mortgage. Your lender finessed this potential problem by refinancing the home equity loan, too.

If there's not another loan in front of it, a home equity line-loan is a first mortgage. These loans used to be called second mortgages because they were second in line to get paid in foreclosure. Calling them home equity lines-loans doesn't presume there's a first mortgage.

The differences in the tax advantages between a home equity line-loan and a mortgage depend in large part on the use of the loan proceeds. Refinancing home acquisition debt is for most taxpayers, a tax-deductible expense. There are limits on the tax deductibility when loan proceeds are used for reasons other than to buy, build or improve a home. The best way to determine the deductibility of your home mortgage interest is to work your way through the flow chart labeled Figure A, "Is My Home Mortgage Interest Fully Deductible?" in Internal Revenue Service Publication 936, "Home Mortgage Interest."

You will have to check with your county's tax assessor to see if a home equity line-loan qualifies you for the mortgage exemption on your property taxes. My expectation is that you would qualify for the mortgage exemption since the home equity line-loan is a secured mortgage loan, and in your proposed financing would also be a first mortgage.

The only protection I can see from having a first mortgage versus a home equity loan is if the first mortgage was a nonrecourse loan in the case of a default and the home equity loan was not. Recourse speaks to the lender being able to seek payment from you over and above the security interest they have in the home. Take a look at the Bankrate feature, "Risks of walking away from mortgage debt," to gain a better understanding of the recourse issue.

You want to be sure you're looking at a home equity loan with a fixed rate of interest versus the adjustable-rate home equity line of credit. I'm concerned that your lender is quoting a lower rate on a home equity loan than you could get on a conventional 30-year fixed rate loan. It's possible they're pitching this approach because they can't underwrite a cash-out first mortgage large enough to pay off your outstanding home equity loan.

You may be saving $1,200 per month with the new mortgage, but by extending the loan term out to 30 years from 20 years you're likely to be paying more in total interest expense. What's the goal: lowering the total interest expense, or freeing up funds in your household budget? Refinancing with a 20-year home equity loan will give you a lower interest rate than the 30-year loan. Take a look at Bankrate's refinancing calculators to see how the savings break out for the refinancing.

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To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "Financing a home," "Saving & Investing" or "Money." Read more Dr. Don columns for additional personal finance advice.
 

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