One Loan Versus Two Loans

One of the questions we ask all the time is whether to do your financing as one loan or two loans. Until comparatively recently, one loan was the default option, but people have been learning that splitting their home financing up into two loans can save them significant amounts of money. Unfortunately, this was just in time for second lenders to get burned by the loss in values. As of this revision, currently no lender that I'm aware of is funding second mortgages over 90% CLTV. When this changes, I'll go back to preferring two loans.

There is significant resistance to the idea of having two mortgages on the part of some people. I have never had a conversation where somebody came out and said why they didn't want to split their mortgage into two pieces, but I can offer some hypotheses. Two loans is two sets of paperwork, two checks to write, twice as much paperwork to fill out and twice as many things to keep track of. If I can't show them concrete benefit, they don't want to do it.

In the cases where equity is or is going to be less than 20% of the value of the house, this is not difficult. Sometimes if the client is in a subprime situation anyway, a loan between eighty and ninety percent can sometimes be marginal, but loan amounts at or above ninety percent of the value of the home is pretty much universally better as two loans.

To illustrate why, let us consider a $300,000 home with a $300,000 loan. Let us posit that your credit score is dead average (about 710), and we desire a Full documentation 30 year fixed rate loan for the primary loan, and a thirty day lock, and that this is purchase money.

When I originally wrote this, I used a price sheet on a random "A paper" lender from my deleted files a few days old, and priced accordingly. I'm retaining those numbers even though they are no longer applicable as an illustration. Since A paper price sheets change every day, this is intentionally stuff I can't (exactly) do right now, used as an example lest somebody in the Department of Real Estate otherwise construe this as a solicitation. Furthermore, I was pricing at "par", no discount or rebate, so no points, to create a real comparison at the same cost. If wouldn't be valid if I was pricing a loan package that took two points against one with all closing costs paid.

If we do it at par, this would have been 6.375%. To this would be added a charge for PMI of about 2.25% on the entire value of the loan, making your effective rate 8.625%. Furthermore, the PMI component is not deductible. Your payment is $1871.61 plus $562.50 PMI for a total of $2434.11, or which only $1593.75 is potentially tax deductible. If you want to make it deductible by adding it into the rate, the payment goes to $2333.36 with potential tax deductions of $2156.25, so that's a benefit right off, but you then have to actually refinance in order to get rid of PMI as opposed to having it removed automatically if and when your home value appreciates sufficiently. Nonetheless, most people do refinance so I'll assume this is what you do.

Now let's price it out as two loans. Par is 5.875 percent for the 80 percent loan. Doing the second as a 30/15 gives a rate of 8.75. This means it's thirty year amortization, but the balance is due in fifteen years as a balloon - so you either have to pay it off by then or refinance by then. Nobody does 30 year flat fixed rates on 100 percent seconds at any kind of decent rate. Better to do is as a 30/15 second. Doing it as a variable rate home equity line of credit gives a rate of 8.75 also.

The payment is $1419.69 on the first, fixed for thirty years, and $472.02 on the second. Total payment $1891.71, potential tax deduction $1175.00 plus $437.50 for a total of $1612.50.

Comparing the one loan versus two loans directly, and assuming you're in the 28 percent marginal tax bracket with standard deduction of $9600 and assuming your other deductions of $5000 and you did get to deduct 100% of mortgage interest, for one loan you get a tax savings of $5975, plus principle paid down of $2211 - but your total payments are $28,000.32 over the year. Net total cost to you is $19814. For splitting it into two pieces, you get tax savings of $4130, remaining principal paid down of $3448 total, and total payments is only $22,700. So your net total cost is $15,123 - a savings of $4691, plus you owe $1237 less next year, on which you will pay $74 less interest.

So you see, there are concrete advantages to having your loan split into two pieces.

Loan officers, however, typically get paid either zero or a flat fee for the second mortgage, whereas they get a percentage for the first mortgage, so they may be motivated to sell you on doing one loan to increase their compensation. As you can see, this is not usually in your best interest. Matter of fact, if your loan is above the conforming loan limit (currently $417,000 for a single family residence) it can be beneficial to you so split it into a conforming loan and a second for that reason alone. If you shop around, you increase the chances of finding a loan officer who will do the loan from the point of view of what works best for you, rather than what best lines their own pockets.

Caveat Emptor

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