Using a Second Mortgage to Avoid a Jumbo Loan

January 27, 1999

"I was recently advised to reduce my loan amount from $245,000 to $240,000 on the grounds that above $240,000 the interest rate is significantly higher. Is that right?"

Yes. Two "government sponsored enterprises", Fannie Mae and Freddie Mac, buy enormous amounts of mortgages from the lenders who originate them, and drive down the rate. The agencies, however, are subject to a maximum loan amount, which currently is $240,000. Hence, the home loan market splits at that point, with the interest rate on loans larger than $240,000 -- sometimes called "jumbo" loans -- from 1/4 to 1/2% higher.

If reducing your loan to $240,000 would put you in a cash bind, the best way to deal with it is to borrow $240,000 on a first mortgage and the amount you need above that on a home equity loan or second mortgage. How much you could pay for the second mortgage and still come out ahead depends on the total amount you need, the rate difference between loans above and below $240,000, and whether or not you want the second mortgage to pay off faster than the first mortgage.

The table below illustrates these points, assuming that the rate on a 30-year loan of $240,000 is 7%. If you need $245,000, for example, and the rate on a jumbo first mortgage for that amount is 7 3/8%, you could afford to pay up to 22.1% on a 30-year second mortgage, and up to 21.2% on a 15-year second mortgage. If you can get a second mortgage for less, you come out ahead using the second mortgage. If the second mortgage rate is higher than those shown, you do better taking the jumbo first mortgage.

Highest Rate You Can Pay On a Second Mortgage When the First Mortgage Rate on a $240,000 Loan is 7%
  Jumbo 7.25% Jumbo 7.375% Jumbo 7.5%
  Term 30 Years
Total Amount Needed      
$245,000 17.3% 22.1% 26.9%
255,000 10.8 12.6 14.4
265,000 9.4 10.6 11.7
  Term 15 Years
$245,000 15.7 21.2 26.3
255,000 7.7 10.0 12.2
265,000 5.8 7.4 8.9

September 7, 2004 Postscript: The maximum loan is currently $333,700.

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