Refinancing a mortgage from a lower interest rate to a higher interest rate is something most borrowers want to avoid whenever possible, but can be a harsh reality when a homeowner is looking to access their equity.
As a result, second mortgages have exploded in popularity recently. Making two different mortgage payments with different interest rates can make it challenging to understand exactly how much interest a borrower is paying. Fortunately, there is a concept called a blended mortgage rate that resolves this confusion.
A blended mortgage rate combines your 1st and 2nd mortgage interest rates to provide a true effective interest rate for the borrowing cost on your home. As mentioned, this allows for a more clear picture of how much interest you are paying. A more useful benefit of the blended mortgage rate concept is that it allows you to compare whether you should refinance your first mortgage or take out a second mortgage.
While most people assume that taking out a second mortgage is always better than refinancing their first mortgage to a higher interest rate, this assumption is wrong. There are times when refinancing to a higher interest rate will actually allow you to pay less interest than taking out a second mortgage. This occurs most often when the second mortgage balance is large and/or the second mortgage interest rate is significantly higher than a new first mortgage rate.
For example, let’s assume an individual owes $100,000 on an existing first mortgage locked at an interest rate of 3.5% but is looking to pull out another $100,000 from their home. This individual has two options: refinance the existing mortgage and take out a new amount for $200,000 in the current rate environment or take out a second mortgage without altering the existing mortgage.
The first option results in a new loan balance of $200K with a hypothetical interest rate of 6.99%. The second option results in the borrower keeping their current loan for $100K at 3.5% and adding a second mortgage of $100K at 10.99%. Which option is better? In this case, the borrower would want to refinance their first mortgage as the payment would be $1,329 vs a combined payment of $1,401.
Rather than looking at blended interest rate calculators online to make this determination, we suggest you speak with one of our mortgage loan originators who can make assessments based on your specific situation and the current interest rate.