Dear Dr. Don,
For the past six years, I have had a $240,000, 30-year fixed-rate mortgage at 5.375 percent on a home worth about $490,000. Four years ago, I got a home equity line of credit for $100,000 at prime. Rates have dropped since then and I am thinking about refinancing the two loans into one loan.
I’d like to go with either a 30-year or 20-year fixed-rate loan, although I can afford a 15-year fixed-rate loan. I will have one child in college in three years and another in six years and expect to take on student loans to finance their college expenses. I have no plans to move within the next 10 years. Which refinance makes more sense given my situation, and should I roll the HELOC into the first loan?
— Howard Homeowner
Because you don’t need to restructure your debts to make the monthly payments more affordable, your goal should be to minimize the effective interest expense. Because the HELOC is an adjustable-rate loan, staying in that loan has you accepting the risk that the prime rate heads higher in the future. For now, that’s not a problem — the prime rate is currently at 3.25 percent and is expected to stay at or near that rate over the near term.
You have a very good rate on your existing first mortgage. However, today’s mortgage rates are very low. As I write this reply, Bankrate’s national average for a 30-year fixed-rate mortgage is 4.88 percent and a 15-year fixed-rate mortgage averages 4.33 percent.
That should mean you can lower the interest rate on your first mortgage by 0.5 percent to 1 percent, but you’ll pay 1 percent to 1.625 percent more than the current interest rate on your HELOC by refinancing into a new first mortgage. The blended rate on your existing loans is approximately 4.71 percent but with the risk that it can go higher.
If it were me, with a 10-year horizon for being in this house, I’d want to get out from under that interest rate risk while fixed-rate mortgages are at such low rates.
I’m a big proponent of financial flexibility. My concern in recommending a 15-year fixed-rate mortgage is that the payment you can afford now becomes less affordable when the children are in college. If you don’t share that concern, go with the 15-year fixed-rate mortgage.
Aggressively paying down mortgage balances may give you the ability to re-tap that equity for college costs. This can be an alternative to taking out Parent Loans for Undergraduate Students, or PLUS, loans. While we don’t know where interest rates for home equity are headed — or where student loans will be when you need to take out the loans — the fixed interest rate on a Direct PLUS Loan is 7.9 percent starting in July 2010.
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