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Conforming mortgage rates dropped this week to levels close to what they were a year ago, which, for those who don’t follow the market, is pretty low. Conforming loans are $417,000 and less. Many of my clients are in California, and a lot of loans out here are over that conforming limit and thus are considered “Jumbo” loans; unfortunately, the jumbo market has been really bad lately and rates have been high; fortunately, there is an alternative if you’re considering a loan over $417,000.
I’m sure you understand what a second mortgage is, so I won’t go into that, but splitting the Jumbo loan into two smaller, Conforming Loans will allow you to take advantage of much lower Conforming rates without settling for a smaller loan altogether. So how is it done? It’s really quite simple.
Let’s say you want to refinance your house with a current loan of $500,000; to avoid paying Jumbo rates, you can split that loan into a $417,000 first mortgage and an $83,000 second mortgage or Line of Credit. Currently, the rates on the first mortgage at $417,000 would be around 3/4% lower than the rates on a first mortgage over $417,000.
Now, here’s where the tricky part comes in. Interest rates on second mortgages and Lines of Credit are always higher than on Firsts (Remind me to explain why in the future). So, while you may be saving 3/4% by keeping your first mortgage at or below $417,000, the second mortgage could be 1/2 to 1% or higher than current Jumbo rates, and 3% or higher if the second is a Line of Credit. I may have lost you on that, so let me illustrate.
Imagine you could qualify for a Jumbo mortgage at, say, 6.875% on a 30 year fixed. If you cut that in two, you may qualify for the first mortgage ($417,000 or less) at around 6.25% and a second mortgage, if fixed, at around 7.25%, or 9% if the second is a line of Credit. You may be looking at those numbers thinking, why would I take a 9% interest rate on a line of credit when I can just get one Jumbo loan at 6.875%? Here’s why: Because, if you split the loan in two, the majority is on the first mortgage at 6.25% as opposed to one Jumbo loan at 6.875%. Because all that money is held at 6.25% as opposed to 6.875%, the benefit of that lower interest rate may outweight the higher rate on the second mortgage, thus balancing out to what we in the industry call, a lower Blended Rate
What’s a Blended Rate?
To find out if it’s a good idea to split your mortgage in two or just go with the higher Jumbo interest rate, you need to calculate the Blended Rate (or have your Broker do it for you). The blended rate is simply a weighted average of the loans on your property if the loans are all at different interest rates. Remember college, where an ‘A’ was worth 4 points when calculating GPA? But remember also that an ‘A’ in a 5 credit-hour class was worth more than an ‘A’ in a 2 credit-hour class? That’s a weighted average, and your GPA in college was calculated just like the Blended Rate on your mortgages, except instead of credit-hours determining the weight, the loan amount does. With that said, I’m about to lose even more of you, but let’s take a shot at the Blended Rate formula. (Disclaimer: If math makes your brain hurt, stop reading here. 
)
LTV1 = LTV of first mortgage (LTV = 1st Loan Amount / Value of Home)
CLTV = Combined LTV of first & second mortgages (CLTV = (1st Loan Amount + 2nd Loan Amount) / Value of Home)
R1 = First mortgage rate
R2 = Second mortgage rate
W1 = Weight of the first mortgage
W2 = Weight of the second mortgage
Here’s the formula:
W1 = LTV1 / CLTV
W2 = (CLTV - LTV1 ) / CLTV
Blended Rate = ((W1 x R1 ) + (W2 x R2 ))
So, for the example above, and assuming the property is worth about $700,000, let’s calculate the Blended Rate:
LTV1 = $417,000 / $700,000 = 60%
CLTV = ($417,000 + $83,000) / $700,000 = 71%
R1 = 6.25%
R2 = 7.25%
W1 = .60 / .71 = .85
W2 = (71 - 60) / 71 = .16
Blended Rate = ((.85 x .0625) + (.16 x .0725) = .0531 + .0116 = .0647 = 6.47%
So the blended rate in this case is 6.47%, and since that’s lower than the Jumbo rate of 6.875%, you should split the mortgage in two and you’ll save more money.
Related Articles:
Jumbo Loans Stage a ComebackJumbo Loans Have Gone Haywire - Market Update
This Hasn’t Happened in a Long Time - Fixed Mortgage Rates at 4.375%!
Jumbo-Conforming Loan Limit Up to $729,750
Mortgage News - Afternoon Edition - Friday, May 02nd, 2008