Refinance Help (Grace or others!), interest only loan

[katygirl]

Help!

I am considering refinancing my home to a interest only loan. My interest rate will start at 1.5% and over 10 years climb to about 6.0%. I may get out of this loan without a penalty after one years time. If I choose to stay in this loan over ten years there is a guarantee that the loan will NEVER go over 9%. It is my hope that after ten years, I will be able to take the 20 years I have left and refinance it into a 15 year loan. Although after a couple of years of this loan if interest rates are decent I will probably fefinance into a fixed rate mortgage. I know paying off ONLY interest is a bad thing. So I plan on sending in an extra $200.00 a month which will be applied directly to Principal each month. I don’t have a mortgage statement with me right now, but I want to say that is all that is allied to the principal each month on our current loan.

The reason why this loan is so appealing to us is that it will allow us to save some much needing money. When this loan ends in 10 years we won’t have kids in daycare (hopefully!) so our cash situation will be different then it is now (hopefully!) Is there another loan you would recommend if you didn’t recommend this one?

We bought our home last year, so where we stand right now we have 29 more years of a 30 year fixed loan and our interest rate is 5.75 percent.

Neither my husband nor I are terribly savvy about mortgages. Should I run far, far away from this loan? Should I be looking at some of the fine print, that I haven't thought of?

Help, please.
Thanks so much!
Katy

[Grace]

I know paying off ONLY interest is a bad thing.

That is sooo not true. It could be true, but it's not true in every case, so one can't make that blanket statement.

It kind of depends on where you live and how long you realistically expect to stay in your home. There is a prevailing wisdom that says you can take the extra $200.00 you were planning to put toward your principal and invest it somewhere in a long-term investment that would average something like 10% (or whatever). Since you're borrowing money so inexpensively, it makes sense (to some) to invest any extra in something that can make your money work for you.

If, for example, you have a home that cost you $200,000, and you have a mortgage on that home for $200,000, your house is going to increase in value (depending on where you live), let's say 5% a year. It's going to increase in value whether you have a $200,000 mortgage or no mortgage at all. Some people believe that putting the $200.00 a month into your home is like stuffing it into your mattress. It's not doing anything for you there.

The problem lies (is that right, Maureen?!! :D ) with what you invest the extra money in. You risk losing that money I guess, technically, although historically, the usual investments always make money over the long term.

Also, banking on your future is not a dumb thing either. In other words, paying the interest only, while using the extra money to pay for things like child care, whatever, is no different than taking a home equity line to do those things. As long as you live in an area where there is not a big risk of your home going down in value, and you're borrowing money inexpensively, and you're able to write the interest off on your taxes, it's not necessarily dumb. You know that down the road your circumstances will change, you'll be making more money, you'll have fewer expenses, etc., all the while your home value will be rising, so you'll be building equity that way.

So to sum up, interest only is not always dumb. It's one product among many, just like different kinds of insurance policies or whatever. You get the product that meets your needs, period. It also has to do with what you are comfortable with. DH and I got started late with our retirement savings due to divorce and some other circumstances. So we have a 15 year fixed on our house because we want to build our equity as fast as we can since we're already in our 40's, and our retirement funds will be woefully short. It just makes us feel more comfortable knowing that we will at least have whatever our house is worth when we retire (which should be a good chunk). We can always move to another place where housing is much less expensive and use the rest to invest further and live off of.

I think you are considering an Option Arm based on your description. In which case you will be offered on your statement each month the ability to pay something even less than just the interest portion, which would result in a negative amortization. I don't recommend that, of course. But as long as you pay at least the interest portion in full, you should be just fine.

[KimE]

In a word: NO :eek:
Don't do it. Grace gave a great explanation on it.
Kim E

[Grace]

I'm confused Kim - why do you say no so emphatically? My explanation basically said to go ahead and do it if you want, and you said my explanation was a good one, yet you still say no way. I'd like to hear your thoughts. :)

[kima]

Your usage of "lie" was correct Ms. Grace. :) ;)

[katygirl]

Thank you SO much, Grace for your explanation, you really know your stuff! I live in Massachusetts, and house prices are pretty darn high. Right now we owe $247,000 on a house that is valued at approx. $460,000. You are right, it is an option ARM that we are looking at.

KimE, Why No? I'd love to hear your thoughts!

Thanks Ladies!

[Beth]

I think the most important thing is to make sure that you understand all the nitty gritty fine points, that you read the documents and make sure you assess the options. Don't rely on what anyone tells you. The loan docs are what you will be stuck with and anything anyone said won't be worth anything after the papers are signed.

Interest only over the lifetime of a loan won't get you anywhere, will it? You borrow money and still won't own anything until you get that principal paid off. On the other hand, you pay interest instead of rent, and if your house is worth more later than it is now, you've come out ahead. I think one of the real dangers in an interest only loan is in areas where the real estate market may have been overheated and values could fall before they rise again. If your house windes up being worth less when you go to sell it, you will have to come up with the difference. It's really tough to look at having to pay money to move out of a house when you expected to gain equity.

That said, in the short term, the difference may not be that great. If you pay down your principal even $25 a month in the first year, you will probably have paid down the principal more than you would with a standard 30-year mortgage payment schedule.

Have I talked in a circle? Well, maybe to an extent. As Grace said, you can't really give a blanket answer. What is best for you will depend on your situation and the assumptions you make about your future. It also matters whether you would spend the money saved on a mortgage on other living expenses (maybe you are pushing things too thin) or whether you would possible spend some and invest at least half of it (maybe building a better college/retirement scenario).

DH and I bought this house with a 30 yr fixed thinking that we would not do any better on the rate (a 15 yr was virtually the same at the time so we took the flexibility of paying the principal on a 30 yr schedule or paying more when we wanted to). We refinaced only about a year later with a rate about 2 points less, and now we are paying the loan off on a 10-11 year schedule. Our plan is to have the house paid off when DH retires and the boys are in college. We plan to stay here unless the house becomes too much for the two of us and me downsize at some point. Our goals are very different that a younger family trying to build, dealing with childcare (ouch -- been there), and possibly moving to another area, a larger home, etc.

Take your best assumptions about what you want and what you expect for the coming years, be a little bit conservative to give yourself some breathing room, then take your best shot. Know what your options are and what your risks are. Don't take a risk you can't afford, and don't be afraid of taking a reasonable risk so that you can make bigger gains elsewhere.

The only smart move is to become mortgage savy and make the best move for you that you can.