- The Washington Times - Wednesday, November 1, 2006

Q:My husband and I need to increase the size of our house and have completed

preliminary plans for an addition. It is expected to cost between $150,000 and $200,000.

We have an existing mortgage in the amount

of $320,000 with a fixed rate at 6.125 percent. Our property will appraise as-is for about $700,000.

Here’s our dilemma: Do we refinance our existing mortgage to a higher interest rate and take cash out, leaving us with one loan or do we keep our current mortgage with the low rate and take out a second trust with a higher interest rate?

We’re not sure which plan makes more sense.

A: I certainly understand your dilemma. On the one hand, you don’t want to lose your 6.125 percent fixed rate, as it is a little bit lower than today’s market rates. On the other hand, a $200,000 second trust will carry a higher rate than what the market can offer on a first-trust mortgage.

The dilemma can be solved by making a calculation called a “weighted average.”

A weighted average is simply a calculation of the average interest rate of your mortgage debt while taking into consideration the balance of each loan.

I see that a fixed-rate second trust will carry an interest rate of about 7.75 percent.

Let’s calculate the weighted average assuming you take out a $200,000 second trust.

First, take your first-trust interest rate and multiply it by the balance: $320,000 times 6.125 percent equals $19,600. Now let’s do the same thing with the second trust: $200,000 times 7.75 percent equals $15,500.

We then add the two sums together for a total of $35,100.

To find the weighted average, we take this sum and divide it into the total mortgage debt: $35,100 divided by $520,000 equals 6.75 percent.

To determine whether it is the better option to take out a second trust and keep the low-interest-rate first trust, we simply need to find out if there’s a cash-out first-trust mortgage rate that’s lower than 6.75 percent.

I see that as of today, a $520,000 cash-out refinance would carry an interest rate of about 6.625 percent, one-eighth percent lower than the weighted average of the first- and second-trust combination.

Unless you plan on accelerating the payoff of your mortgage debt by making extra payments, it probably makes sense to refinance your first trust and avoid the higher-rate second trust.

There are a couple of other things to consider. Make sure you know all the costs associated with each loan. If the closing costs are significantly higher for the refinance, you probably are better off taking out a $200,000 second trust.

Also, carefully consider the accuracy of the cost of your addition. It may make sense to take out $150,000 in cash instead of $200,000. If you find that the addition ultimately will cost more than $150,000, you can take out a home equity line of credit (HELOC) for $50,000. This will allow you to borrow the exact cost of the addition because a HELOC allows you to borrow any desired amount of money by drawing against it.

A good loan officer can spell out the details for you.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]pmcmortgage.com).

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