Q: My wife and just closed on our first home yesterday and we are feeling the usual buyer’s remorse and angst. But we also have a concern that I would like your opinion on.
Our home cost $124,000. We put down only $4,000 in cash. Our bank talked us into taking out a home equity line of credit in order to avoid paying private mortgage insurance. So our mortgage is for $97,000 and our HELOC, which is interest-only for fifteen years, is for $24,000.
After the closing, we starting thinking about the reality of our interest-only loan. We have 15 years before we are faced with the balloon payment. We have adjusted our budgets to include paying double to triple the payment on the HELOC in order to have the loan paid-off by the time the 15 years are up.
But the idea that this loan might not go away in 15 years really scares us. Did we make a bad choice? We were told that the PMI on our loan would be a rather large sum of money each month, so it made sense to avoid that. But now I feel as if we were misled in order for the bank to simply sell another product.
I have no idea what our options are. Should we refinance? Should we sit on the budget for a couple years and then look to refinance then? We are tempted to go to other banks and try to refinance through them, but the loan just closed and we can’t see paying more closing costs.
We feel stuck. Did we do the wrong thing?
A: First things first: calm down. I think you made a smart choice, given the options at your disposal.
Because you were putting down almost nothing, private mortgage insurance or PMI would have been quite costly. And, because you cannot current deduct insurance premiums from your federal income taxes, you chose to get an interest-only home equity line of credit or HELOC. Because you’re only paying interest on the HELOC, everything you pay will be deductible. All in all, that was a smart move.
What else could you have done? You could have bought a less expensive home. In my mind, your banker steered you to an interest-only HELOC because that’s what you could afford. With a less expensive home, you might have had other options.
But you’re already doing another smart thing: You’ve adjusted your budget so that you can throw loads of cash against your home equity loan. Not only will you start to build up the equity in your home, you will also pay off this loan much sooner than 15 years because the interest on your loan is calculated against the entire principal. As you pay that principal down, you will owe less interest on the loan. If you keep paying at the same rate, even more of your payment will go toward the principal, so the loan will be paid off more quickly.
I think what you need to do now is relax a bit, and enjoy your home. Watch how much you’re spending and realize that in a few years, your home will hopefully appreciate in value and you’ll have built up more equity by paying down both your loans. Finally, I hope that the HELOC loan is a fixed rate loan. If the rate is fixed you won’t risk having interest rates increase on you. If the rate is variable, you may want to consider finding a lender that can offer you a fixed-rate HELOC for the fifteen years of your loan. written permission from the publisher.