Refinance likely, thanks to equity cushion

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Dear Dr. Don,
I have a second home worth about $110,000 that has $57,000 remaining principal on a first mortgage at 6.375 percent with 11 years left on the loan. Our primary residence is paid off and worth about $320,000. I’d like to do some home improvements to our primary home (about $25,000) and am considering options such as a refinance.

Can I combine the balance of the first loan with a home improvement loan and get more attractive rates using either property as the collateral? Our FICO score is over 800.
— Dave Denouement

Dear Dave,
While lenders have gotten more conservative about cash-out refis, owning your first home free and clear makes borrowing $82,000 against the home with an estimated value of $320,000 — especially with your credit score — an easy decision for the loan committee.

The downside of a first mortgage refinance is the higher closing costs associated with that mortgage. Bankrate’s national average for closing costs on a $200,000 loan in 2009 was $2,732. You should definitely look at a shorter-term mortgage, like a 15-year fixed-rate mortgage, so you don’t end up spending a ton of money on interest by extending out to 30 years. As I write this, Bankrate’s national average for a 15-year fixed-rate mortgage is 4.46 percent.

The interest rate differential between a new 15-year fixed-rate mortgage and your existing 6.375 percent mortgage on your second home should give you enough of a reduction in interest expense to justify the refi on its own. Getting the remodeling money at this rate versus prevailing rates on a home equity loan (7.76 percent) or home equity line of credit (5.76 percent) is another bonus.

Bankrate’s Refinance interest savings calculator can help you figure out what you’ll save on the refinancing component.

Doing this maneuver with the second home should also work. If your estimate of the home’s value comes close to the appraised value, you’ll have a loan-to-value below 80 percent and won’t have to pay private mortgage insurance.

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