Brian Brady at America’s Mortgage Broker wrote a masterful article explaining how to use Weighted Average Cost of Capital (WACC) as a financial tool to calculate whether or not a borrower should refinance to consolidate their mortgages and consumer debt. Many times a potential client has an extremely low rate on their first mortgage and possibly a HELOC and other consumer debt. By calculating the WACC of the borrowers total debt, one can better determine if a refinance makes sense.
According to Brian Brandy:
“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 + $50,000= $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%”
Go to Brian’s full post where he goes on to explain how to also calculate the tax benefits of refinancing.