Refinance to survive a cash-flow crunch

May 29th, 2009, 3:00 am · 4 Comments · posted by Mathew Padilla

Randy Johnson, president of Independence Mortgage Co. in Newport Beach, author of “How to Save Thousands of Dollars on Your Home Mortgage” and a mortgage broker since 1983, answers questions…

CashPoor in Laguna Beach asks:
Q. We have a fixed, 5.125%, 15-year (11.5 years left) 1st mortgage of $346,955. Our second mortgage is $182,403 at 2.9% recently (rate varies). We have reduced monthly income due to salary cuts. We’re paying interest-only on the second mortgage (this month $430). I’d like to eliminate the second mortgage payment to help with monthly cash flow. Can I combine the two mortgages to $529,358 at a reduced fixed interest rate, over 15 to 20 years amortized and end up with just what my primary mortgage payment is right now, $3,587 (or close to it)? We have no termination fee on the 2nd. Our FICO is just over 760. Our home is a single family home in Laguna Beach with an Internet appraisal of $1.6 million. It could be worth as little as $1.4 million in this market. I’m trying to weather a two-to-three year cash flow reduction but not at a total disregard for our future mortgage debt since my husband is in his late 50s.

A. Good question and I’m sure many readers are also tuned in because they are in similar situations. You have a good 1st mortgage and a good 2nd too for that matter. Absent the loss of some of your income, I’d have suggested you keep the loans and devote cash flow to making the 2nd disappear. In your case that is not possible at present, so that makes a refinance more attractive.

The advantage of refinancing now is that you can combine them at about 5% and take out the rate risk on the 2nd as in, if and when rates move higher. Before you gag when you see what closing costs are, it will be helpful to look at them as the price of an insurance policy that you will not have to pay 7% or 8% on your 2nd some day. Calculate what the annual interest is at those rates and you will feel better.

Note that with salary cuts, you will still have to qualify for this loan even though you have good credit and low LTV.

(Editor’s Note: Combining the first and second for a total of $529,358 at 5% over 20 years results in a monthly payment of $3,494. That’s slightly less than what CashPoor pays on her first mortgage. Payment calculated with Excel’s mortgage calculator. Also, Randy Johnson answered this question before rates become volatile. To get 5%, one may have to pay a point or more.)

That’s it. If you want Johnson to answer a question, email it to Mathew Padilla at mapadilla(at)ocregister.com. Include your name or nickname and the city you live in — that information will be published with your question.

Johnson will answer up to three questions each week, so keep checking back for a response. If many questions are submitted, it could take a while to get a response, or he may never get to it. Also, readers keep submitting variations on the same question, which has already been answered: what to do when you can no longer afford your mortgage. I have decided not to publish most of those questions, because they are repetitive, although I appreciate the difficult situation many homeowners are in these days.

Read prior questions and answers by clicking on the headlines below…

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Mathew Padilla, Reporter says:

May 29, 2009 at 7:46 am

To all,

Randy answered this question just before rates jumped.

Post Reply

lee in irvine says:

May 29, 2009 at 8:51 am

From Mr. Mortgage’s blog~

“GSE Jumbo fixed rate loans were decimated on Wednesday. This market is highly volatile to begin with — a move like this blows rates out until conditions settle down quite a bit. Anyone with an unlocked GSE Jumbo loan that was hoping for the 5% rate available when the application was taken is out of luck. Jumbo fixed wholesale rates are now 6% to 7% depending upon which lender the loan is with.”

Surprised says:

May 29, 2009 at 10:10 am

This was a good post because it is exactly my situation also except my loan to value is a bit higher at 63%. My second was used for an add on and new hardscape, master bath remodel etc. Now paying off a second is viewed as “cash out” apparently and the points are even hgher than 1% or so I am told.. So I have done nothing which makes me a bit nervous.

Liar Loan says:

June 1, 2009 at 2:46 pm

This was a great question, but unfortunately part of Randy’s answer demonstrates his terrible financial planning advice:

“Absent the loss of some of your income, I’d have suggested you keep the loans and devote cash flow to making the 2nd disappear.”

First of all, paying down your mortgage may not be good advice in a low rate environment like right now. If you can get a better rate in corporate bonds or municipal bonds than you could by paying down your mortgage (after tax deductions are factored), you should probably invest your money instead. The only people that should think about paying down their mortgage in this situation are those with extremely low risk tolerance i.e. they have all their savings in CD’s, and other guaranteed investments that pay very low rates. However, if your income is prone to fluctuating with the economy, it may be a bad idea to pay down the mortgage anyway if you need live off savings during slow periods.

Secondly, why would you ever… ever… pay down a 2nd mortgage with a 2.9% rate when you have a first mortgage of 5.125%? Both loans are tax deductible so the tax consequences would be the same, however paying down the higher rate is what you ALWAYS want to do, all else being equal. If and when the second mortgage rate floats higher than the first mortgage, that’s when you’d want to switch and start paying down the second. This is the strategy that will help you pay down your debt the QUICKEST.

A refi would be in her best interest if the potential savings in INTEREST would cover the up front costs within a reasonable amount of time (2-3 years is a typical rule of thumb). Remember though, if you start over with a 20 year loan, it reamortizes the mortgage over a longer period of time (20 years vs. 11.5 years ), meaning interest will be paid over the additional 8.5 year life of the mortgage even though it makes your monthly payment lower.

In this case, a refi would be a bad idea unless the idea of having a lower payment locked in for the next 20 years is worth the higher dollar amount of interest you will pay over the life of the loan. It’s an expensive trade off.

Orange County Register