Combine Mortgage, HELOC in New Loan?

Dear Dr. Don,

I have 18 years and $55,000 left on a 25-year fixed-rate mortgage at 5.125%. I'm also five years in on a home equity line of credit, or HELOC, with a $97,000 balance currently at a variable rate of 2.78%. I'm at the end of the draw period of the HELOC. I plan to be in this home for at least another 10 years. Would it be wise for me to combine the two loans into a 15-year fixed-rate mortgage?

-- Daniel Dovetail

Dear Daniel, When I wrote you and asked for some additional information about your HELOC, you didn't know a lot of the parameters about the loan such as its maturity date, when or if the HELOC converted from interest-only payments to amortized (principal plus interest) payments, or if there was a balloon payment due on the HELOC.

These variables along with the particulars concerning how the interest rate adjusts on the loan are all factors in the decision about whether to combine the two mortgages into one fixed-rate refinancing. You want to know the pricing spread on the HELOC, whether there is a minimum (floor) interest rate, a maximum (ceiling) interest rate and the maximum change on an interest rate reset.

I suggest reviewing your loan documents for the HELOC. Talk to your loan servicer if you can't find the answers by reviewing your loan documents. My guess is that your loan is priced at 0.5% below the prime rate, and that it doesn't have a floor. I'll also hazard a guess that the HELOC lender won't let you refinance the first mortgage without paying off the HELOC, which is what you are considering.

You currently have 63% of your mortgage loans at 2.78%, and 37% of your mortgage loans at 5.125%. That gives you a weighted average mortgage rate of 3.64%. Bankrate's national average for a 15-year fixed-rate mortgage was, as of late June, 3.62%.

The good part about refinancing is that you take the risk of the HELOC's interest rate trending higher over the next decade out of the picture, plus you lower the interest rate on your fixed-rate mortgage. The downsides are that you have to pay closing costs on a new first mortgage, and you've increased the current interest rate on 63% of your mortgage debt.

Because I don't know the loan term on the HELOC, I can't say whether you're extending the loan term by refinancing into a 15-year mortgage. When you extend the loan term, it's possible to pay more in interest expense, even with a lower interest rate, because of the extension.

Take a look at Bankrate's calculator that compares an ARM to a fixed-rate mortgage to see how projected increases in the prime rate over time could increase your interest expense on the HELOC versus refinancing it with a fixed-rate mortgage. The calculator allows you to provide an estimate as to the trend in interest rates and uses that estimate to compare total interest expense against the fixed-rate loan. You know you'll have savings in refinancing your current fixed-rate loan, and that's why I'm suggesting you focus on what could happen to the HELOC.

I'd lean toward refinancing just to take the interest rate risk off the table. You plan to be in the house for at least a decade. Mortgage rates have to be at or near as low as they'll go. As long as closing costs aren't excessive, it's worth it for that certainty. Bankrate's 2011 Closing Costs Survey will give you an idea of what to expect in your state.

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