Some moves make bad-loan status worse

2 min read

Dear Dr. Don,
Should I refinance? We purchased a home two years ago at $235,000. We found a good deal on a home and wanted to buy, so we did so even though we still owned our starter home.

In order to purchase the house, we did an 80/20 split. The 80 is $185,000 over 30 years at 5.35 percent. The 20-year loan is basically a balloon due in 10 years for $45,000 (I think it’s at 10 percent) and we pay $392 per month for it.

Should we give up our good loan to get a higher interest rate now and eliminate our “bad” loan? Or should we wait? Or should we try to put more cash to the second loan to pay it down?

We have long history of on-time payment, but we carry about $6,000 in credit card debt and have a car loan for $21,000. My wife and I make a combined income before taxes of $128,000 yearly.

Charlie Compounding

Dear Charlie,
Two key elements in your decision to refinance are how long you plan to be in the house and what you expect the home would appraise for in today’s market. You did an 80/20 piggyback loan, which means you had very little equity in the property. If housing prices have fallen, you may not have the opportunity to refinance the “bad” loan.

Charlie’s mortgage debt
  First Mortgage Second Mortgage Combined
Loan amount $185,000 $45,000 $230,000
Interest rate 5.35% 10.45% 6.36%
Estimated payment $1,033.07 $391.88 $1,424.94

The good news is that the blended rate on your mortgage is roughly 6.36 percent, even with that jaw-dropping 10.45 percent interest rate on the second mortgage. That’s a little higher than the 10 percent you thought you were paying, but 10 percent would only have a monthly payment of $375.

Absent the opportunity to refinance, your best option is to work on paying down the 20-year loan by making additional principal payments on that loan. Even if there is a prepayment penalty, it’s typical for the loan to allow a certain level of additional principal payments without penalty.

Combining the two loans into a new first mortgage also would require you to take out private mortgage insurance, or PMI. A rough estimate of the monthly PMI bill is $200 a month. So, you’d be ramping up the interest rate on 80 percent of your mortgage loans outstanding to bring down the rate on 20 percent of your mortgage loans outstanding. And you’d pay $200 a month for the privilege.

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