Q: I purchased a townhouse for $150,000 in October, 2004 using a 5-year adjustable rate mortgage (ARM).
I decided to get an ARM not only because the monthly payments were lower, but because I decided this townhouse would be a short-term purchase of 5 years or less and then I’d upgrade to a single family home. Essentially, I have 3 more years to purchase a new home before my ARM resets to the going market rate or I refinance.
Since owning the house, I have seen my salary increase substantially and I hope to increase my salary even more over the next few years. The townhouse has appreciated nicely in value and I now have roughly $60,000 in home equity according to the recent home sales in my neighborhood.
On the other hand, I think I could get more bang for my buck if I were to look for a new house now. Although I’m single, I can’t stand the tight quarters of the townhouse and really want a single-family home despite my not being married with a family at the moment.
Is it worth paying the closing costs to refinance now to a fixed rate loan even though I’ll probably sell before the ARM resets? Should I look to sell my townhouse now and plow whatever profits I realize into a down payment on a single family house, but risk overpaying for the new house? Or, should I keep my townhouse, and play the “wait and see what the market does” game?
Thanks for any insight you may have!
A: You’ll want to stay in your home until at least October 2006 so that you can keep whatever profits you’ve earned tax-free. Current tax law requires that you live in your home for 2 of the last 5 years in order to keep up to $250,000 (up to $500,000 if you’re married) in profits tax free when you sell. Otherwise, you’ll pay tax on your profits at your current marginal tax rate — which sounds like it might be high given that your income is rising.
While property has appreciated dramatically over the years in some markets, we’ve seen the residential real estate market soften quite a bit in some areas. Since you’re making money on your townhouse, now might be the right time to unload your townhouse and buy a different property in a different area of town that might not be as hot.
If you look around, there should be folks who have had their homes on the market for quite awhile, who may be desperate or anxious to sell. If that’s the case, you may find quite a deal on your next property. If you can sell your townhouse quickly, and close in October, you’ll be able to lock in your profits and find another opportunity.
But here’s another option: If you can swing it financially, you may wish to rent your townhouse and simply use a home equity loan, line of credit or some of your savings as the down payment on the new purchase. If you don’t mind being a landlord, this might enable you to keep the townhouse for its future appreciation and cash flow, and yet move onto bigger and better things.
As far as refinancing goes, I wouldn’t do anything if you plan to sell your townhome in the next few years. Your ARM won’t adjust before 2009 and a lot can happen with interest rates before then.
If you decide to keep your townhouse long-term and rent it, I’d keep your super-low ARM as long as you can, and then worry about refinancing it at that point.
Three years is a long time when you’re 26 and unmarried, and your plans could change. Why spend good money now to refinance a great loan to one with a higher interest rate?
Published: Aug 12, 2006