When most people know they're ready to buy a home, they take steps to improve their credit score and compare mortgage rates among several lenders. After all, you want to know you're getting the best interest rate on what will probably be the biggest loan you ever take out.
Getting a good rate when you buy a home is great, but what happens when the market changes in a few years? A blended mortgage is also an option available to you down the road to lower your interest rate without breaking your mortgage.
Here's what you should know about blended mortgages and the many ways in which they can help you lower your housing costs.
What Is a Blended Mortgage?
A blended mortgage refers to combining or blending the rate from your existing loan with the rate from a new loan to get a new, lower rate that falls somewhere between the two. Because you are essentially keeping your existing mortgage and not breaking your term, you can avoid prepayment penalties that come with a regular mortgage refinance. A blended mortgage can't give you the best mortgage rate available, but it can allow you to lower your rate without a penalty.
Blended mortgages can be used to lower your interest rate, extend your term, and/or access the equity in your home.
There are two primary types of blended mortgages available:
Blend and Extend
This option is commonly used to extend a home loan. In this case, it's called a "blend and extend." With a blend and extend option, your existing interest rate is blended with a current, lower rate to give you a new rate that's somewhere in the middle. You will also receive a new term on your loan that extends it back to the original length.
To demonstrate how it works, imagine you are halfway through a 5-year fixed rate term and you have an interest rate of 5.5%. You notice your lender now offers a 3.5% rate to new borrowers. With the blend and extend option, you can extend your loan back to a 5-year term and get a new blended rate somewhere between 3.5% and 5.5%.
Blend to Term
What if you want a lower interest rate but you don't need to extend the term on your loan? With the blend to term option, you can get a new blended interest rate on your mortgage but your term remains the same. Using the example above, a blend to term agreement would give you an interest rate between your current 5.5% and the lower 3.5% rate but you will still have just 2.5 years remaining on your term.
How to Get a Blended Mortgage
To get a blended mortgage, you will need to request the option from your mortgage lender when interest rates are lower than what you are currently paying. Most lenders require that you are within the first 3 years of a 5-year term to qualify for blending.
Not all lenders offer blended mortgages, though. Ratehub offers a list of lenders that offer blended mortgages and whether they have "blend and extend" and/or "blend to term" options available.
When You May Want a Blended Mortgage
There are many situations in which a blended mortgage can pay off, whether you're buying your first home or want to plan ahead for the future. Here are several ways in which you can use mortgage blending.
Get a Lower Interest Rate
If you buy a home and rates go down within the next few years, a blended mortgage allows you to take advantage of the lower rates without paying a penalty. While blending won't give you the lowest possible interest rate, it can still substantially reduce your rate and your mortgage payments.
Extend the Term of Your Loan
Want to extend your loan term for predictable mortgage payments for the next 5 years? With the "blend to term" option, you can lower your interest rate and extend your term back to the original five years. This gives you more time to pay down your mortgage balance at this lower rate.
Access Home Equity
As you pay down your mortgage, you may decide to access your home equity to make improvements, pay down debt, or even buy a second home. There are three ways to refinance your mortgage: breaking your current mortgage and getting a new loan, taking out a HELOC, or getting a blended mortgage.
If you are facing a substantial prepayment penalty to break your mortgage, choosing a blended mortgage can give you the best of both worlds: a lower interest rate, no penalty, and access to your equity.
Avoid Prepayment Penalties
When you break your mortgage early by selling the home or refinancing, you will need to pay a prepayment penalty. This fee will depend on when you signed your loan contract, your loan term, your mortgage balance, the rate type, and the interest rate. Do you have a fixed-rate mortgage or a variable-rate mortgage? With a fixed-rate loan, this prepayment penalty is the greater of three months' interest or the interest rate differential. With a variable-rate loan, the penalty is three months' interest.
A blended mortgage allows you to essentially renegotiate your interest rate and even extend the term of your mortgage without a traditional refinance. Your interest rate won't be as low as it would with a refinance, but it may save you more money by avoiding this penalty. It's a good idea to use a mortgage penalty calculator to determine which option is best for you, however.
If you're considering refinancing for any reason or you want to have options available to you one day, a blended mortgage is worth considering. This often overlooked option can reduce the costs of a traditional refinance and help you access your equity while lowering your rate.