Save with a piggyback mortgage refinance

Dear Dr. Don,
We were unable to get our equity out of our prior home when we moved because its value had dropped, so we had to use some creative financing to purchase our new home one year ago. Meanwhile, we’re renting out our old house.

We purchased our new home with 5 percent down at 4.5 percent interest through a special 15/30 balloon mortgage program for physicians. We bought the home as a short sale, and the house appraised for $560,000 at purchase. It should be worth at least that much today. The loan balance is approximately $510,000. We are interested in locking in a 30-year fixed-rate mortgage but are limited in our options because of both the outstanding loan balance and the limited equity we have in the home.

We have been offered a refinance with another bank using a 30-year fixed-rate mortgage at 3.875 percent for $417,000, and a home equity line for $87,000 that has a variable interest rate based on the prime rate with a 3.99 percent floor, with interest-only payments for the first 10 years. We would have to come up with the remaining money, which I think we can do. We would like to do this with the goal of paying off the home equity line ASAP, but that will take us several years. Still, I think it would be better than having to refinance in 15 years. We’re using a mortgage broker in the transaction. Is that wise? What is your advice on refinancing?

— Pam Payments

Dear Pam,
You’re being offered a “piggyback” mortgage, where you finance the home with two mortgages instead of one. The benefit of having this type of loan structure is that the first mortgage is at 80 percent or lower loan-to-value, so it doesn’t require private mortgage insurance, or PMI.

In your case, the first mortgage is also sized as a “conforming” loan at the conforming loan limit of $417,000. Conforming first mortgages will almost always have a lower interest rate than a nonconforming loan. The usual downside with a piggyback mortgage is that the interest rate is much higher on the second mortgage. That’s not the case with the variable-rate home equity line you’re being offered, although you are taking on some interest rate risk.

‘Piggybacking’ for savings

80/10/10 Original loan
Home’s appraised value: $560,000 $560,000
First mortgage: $417,000 $510,000
Second mortgage: $87,000 $-
First mortgage interest rate: 3.875% 4.50%
Second mortgage interest rate: 3.99%
First mortgage payment: $1,960.89 $2,626.47*
Second mortgage payment (interest only): $289.28 $-
Total monthly mortgage payment: $2,250.17 $2,626.47
Monthly savings with refinance: $376.30
*Calculated using the time remaining on the loan, 29 years.

Mortgage brokers can provide a valuable service with “story” loans. To me, a story loan is when the lender has to understand your situation to approve the financing.

It all comes down to rates and fees, and the offer you showed me would allow you to further reduce your interest rate by 0.125 percent if you paid $1,000 in closing costs, and by another 0.125 percent if you are willing to put property taxes in escrow. I would suggest taking both those offers, if you can afford to do so, because it will reduce the interest rate on your first mortgage to 3.625 percent, and that would reduce your monthly loan payment by $59.15 — before adding back in the escrow payment.

You refinance when you can expect to recoup your closing costs in the form of lower interest expense within the time you plan to spend in the house. Even if you’re not in this house for 30 years, you’re shaving off between 0.51 and 0.875 percentage points in interest on a home loan worth more than half a million dollars. Make sure there’s no prepayment penalty on the existing loan, and then feel confident in going ahead with the piggyback mortgage refinancing.

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