You told me "I never want to refinance my 30 year fixed rate loan at 5.25% !"

**I told you that I was gonna WACC you if you said dat!**

I often use a formula to analyze a client's borrowing costs that is taken straight from a Corporate Finance textbook. It's called the Weighted Average Cost of Capital or WACC for short.

I'll give you a brief explanation, in layman's terms, of how I perform a WACC analysis. Assume these folks have a $350,000 first mortgage at 5.25%, a HELOC of $100,000 8.5%, and consumer debt of $50,000 at 12%.

1- I total up the amount of your debt. (*$350,000 + $100,000 + $30,000= $500,000*)

2- I determine what percentage of the total debt each individual loan is :

a- First Mortgage (*$350,000/$500,000= 70%*)

b- HELOC (*$100,000/$500,000= 20%*)

c- Consumer Debt (*$50,000/$500,000= 10%*)

3- Now, I "weight" each interest rate you pay for a before tax average cost of capital:

a- First Mortgage (*5.25 * .7= 3.675*)

b- HELOC (*8.5 * .2 = 1.7*)

c- Consumer Debt (*12 * .1 = 1.2*)

4- Add up the weighted rates (*3.675 + 1.7 + 1.2 = 6.575*)

5- So , the REAL, before tax, cost-of capital for this client is really 6.575%**CAN YOU GET A FIRST MORTGAGE WITH A RATE BETTER THAN 6.575% ?**

So, you said, "Yeah, but what about my tax benefits? "

And I replied (as I always do), "Let's plug them into the formula !"*Assume the client is in the 40% marginal tax bracket (for Federal and State taxes)*.

1- The total debt remains the same ($500,000)

2- The percentages of total debt remain the same as the above example

3- Now, I determine the after-tax interest rate for each piece of debt:

a- First Mortgage= (5.25% * .6) = 3.15% after tax

b- HELOC= (8.5% * .6) = 5.1% after-tax

c- There is no tax deduction for the consumer debt so it remains 12% after-tax.

4- Weight the after tax costs:

a- First Mortgage= (3.15% * .7= 2.205)

b- HELOC= (5.1 * .2 = 1.02)

c- Consumer= (12 * .1= 1.2)

5- The real, after-tax, cost of capital is 4.405%**THAT'S A HELLUVA LOT BETTER THAN 6.575%, RIGHT?**

Of course it is. But you forgot that the new first mortgage has tax benefits, too! Now you have to translate that after-tax costs of capital. So, we divide 4.405 by .6 and find out that a first mortgage, with a before tax rate of up to 7.34% still makes more sense than keeping that first mortgage.

In this case study, I refinanced them to a 6.25%, 30 year fixed rate loan with an after-tax cost of capital of 4.0%. Some portion of the new loan may not be deductible due to the Home Equity Interest Deduction Cap of $100,000. We consulted with their tax advisor, and the new loan still made complete sense.

My point of the article is this: Stop shopping online for loans. The average loan hack in a boiler room has no clue about what I just taught you. Rather, look for a mortgage advisor who has had some real financial planning experience or training.

Here are some pros in your neck of the woods:

Illinois: Dan Green

Florida: Robert Ashby

Washington: Rhonda Porter

Utah: Karl Christen