Primary marketEstablish Objectives, Then Choose Mortgage
Question: We moved into our home in February of 2004. We have a fixed rate, first trust mortgage at 6.00 percent. We have a 2nd trust mortgage at 7.00 percent with a fixed rate. I would like to roll both loans into one monthly payment. There are two options that appeal to me but I"m not sure which one is best.
The first option is to take an interest-only 10/1 ARM at 5.875 percent. My payment would drop by $555 per month. The second option is to take a 30-year, fixed mortgage at the same rate (5.875 percent). This would drop my payment by $207 per month.
We plan on being in the property at least 12-15 years, but it"s always possible that we could upgrade into a bigger home within 10 years. Please help me make an informed decision!
Answer: There are so many mortgage programs available that it is often tough to choose the right one. I"m a fisherman so let me use a fishing analogy: Some anglers like flexible, "sensitive" rods and thin line. This enables the fisherman to feel the strike quickly so he can set the hook. The problem is that the big ones often break off. Other anglers prefer a heavier rod with heavier line, hoping that the fish will hook itself. Once it"s hooked, he"s not likely to come loose.
Everything has its tradeoffs.
Okay, I know it"s a weird analogy but here"s the point: You need to know all the advantages and disadvantages of suitable mortgage programs and then decide which features are most important to you. Let"s compare your choices.
Both carry the same rate of 5.875 percent. The 10/1 ARM, however carries some future interest rate risk. After 10 years, the interest rate could go up, depending upon market rates at the time. For 10 years though, your payment is $348 less than the second option because it allows an interest-only payment.
The second option is straightforward. The rate is fixed for the entire 30-year term and the loan will eventually be paid off.
You"re asking me which program is "better." I don"t know -- it depends on what fits into your objectives. Here are a couple of questions that will help you decide:
Are you a disciplined saver? Remember that an interest-only loan carries a low payment but doesn"t curtail the principal balance. Taking the interest-only loan with the lower payment coupled with investing the $348 into something smart, like a tax-deferred IRA or college fund might not be a bad idea. But if you"re an undisciplined saver, you might want to have the "forced savings" of an amortized loan. The last thing I would recommend is for you to take out an interest-only loan only to blow the monthly savings on consumer goods and services.
What do you think a realistic probability is that you will still hold the loan at the end of 10 years? It sounds as if you think you might move within that time. I know it"s difficult to predict your future plans, but do your best to ascertain the probability that you will actually be holding the loan for that long. You never know, interest rates could certainly fall again and you may refinance out of the loan.
This is actually a fairly simple decision because the rate is the same for both programs. In the first, you have the interest-only option but only 10 years of rate stability. The second option fixes your rate for 30 years but you don"t have the interest-only payment option. You need to decide which is more important: Cash flow or interest rate stability.
A couple of additional comments. Make sure that your total loan balance does not exceed 80 percent of the home"s current value. If so, you may be required to pay private mortgage insurance -- something that you need to avoid. Also, make sure you know the total closing costs of each program. Make sure there are no points or origination fees.