Q: I know you don’t have a crystal ball, but I greatly value your opinion. I have a question regarding my mortgage.
I am 63 years old (right now I plan on working until 70 years old) and got into a townhome 3 1/2 years ago. I have a $211,000 at 5.375 percent on a 7-year fixed adjustable rate mortgage. That was 80 percent of the purchase price. I also took out a 10-year variable rate home equity line of credit that is currently at 4.5 percent. The balance on that loan is $36,000.
Should I refinance both of these loans into a 30-year mortgage or wait and see what happens in the next 3 1/2 years before the rate on the ARM goes up?
A: You and many other readers are in the same situation. As I write this, the interest rate on a 30-year fixed rate loan is running around 6 percent. It dipped briefly to about 5.75 percent, just after Treasury Secretary Henry Paulson announced that the government was essentially taking over Fannie Mae and Freddie Mac, but it has since risen.
Adjustable rate mortgages (ARMs) are all over the map. Those that are pegged to LIBOR (the London InterBank Offered Rate) are all over the map at the moment. There is a lot of confusion in the mortgage marketplace over short-term pricing.
Where does this leave you? With an excellent first mortgage at prices that may well be below the market rate at the moment, and a home equity line of credit (HELOC) with a great rate. I don’t know what your HELOC is tied to, but you should be aware that since it isn’t a fixed-rate loan, the interest rate could rise quickly.
There are a couple things you should consider. You should look at the terms of your 7-year ARM. You may find that the terms limit how high your rate change can be in 3 1/2 years. Your ARM has 3 1/2 years left in which the interest rate you pay on the loan is fixed. When your loan interest rate changes, your loan may have certain limits on what your interest rate can do.
Some ARMs limit the change in the increase or decrease on the interest rate to 2 percent. That would mean your loan interest rate when it changes could only go up to 7.375 percent. Historically, that interest rate would still be quite good, but not as good as current rates. (But, it gives you another year in which to wait for interest rates to fall again.) Thereafter, your loan interest rate could go up or down 2 percent each year.
Your loan should also have a lifetime cap on how high your interest rate could go. Some ARMs have lifetime caps of 5 percent or 6 percent above the interest rate paid during the initial period. If that’s the case, your interest rate would never be higher than 10.375 or 11.375, depending on your lifetime interest rate cap.
Why is this important? If you decide to refinance now, you may find that your property does not appraise as high as it did when you purchased your townhome. If the appraisal is much lower, to refinance the property you will have to pay the lender a significant amount of money back to get a new 80 percent loan and you might not find a lender willing to give you a HELOC.
Perhaps fortunately for you, you still have 3 1/2 years to go until the interest rate on your ARM adjusts. Most ARM loan interest rates are tied to either the United States Treasury rates or London InterBank Offered Rate (LIBOR). If these interest rates remain about where they are today when your interest rate readjusts, you may find that your current loan’s interest rate may go down.
However, if interest rates shoot up, the interest rate on your ARM will go up to the maximum increase amount. Your HELOC rate will increase as interest rates increase and those increases will start as soon as rates increase.
If I were you, I’d watch interest rates very closely. It seems to me that while 6 percent is an excellent long-term interest rate for a mortgage, rates might dip one more time before they head up.
If home values have remained constant or, at the very least, homes in your community have increased in value since you purchased the townhome, consider putting in an application with a mortgage lender you trust (try not to pay anything upfront) and see if interest rates head down over the next six months. If they do, you could consider refinancing your primary mortgage. You could include your HELOC in the refinance, but you’ll do better financially if you can get that paid off separately before you retire in the next seven years. If your HELOC stays at 4.5 or even rises to 5.5 percent, you’re still ahead of the game.
If you decide to refinance your ARM mortgage, you might find that your HELOC lender will want to get paid off. If you don’t pay off the HELOC, that lender may not agree to the refinancing.
In the past, most HELOC lenders would allow owners to refinance their primary mortgage and would sign a document called a subordination agreement. This subordination agreement would allow the homeowner to pay off an old first lender, get a new one and keep their HELOC.
But in the current financial environment, many HELOC lenders would like to reduce their exposure to the real estate market. As HELOC loans are paid off, they are not as generous about giving new ones. As homeowners refinance their primary loans, they’re asking those homeowners to pay off their HELOCs.
Some HELOC lenders have gone so far as to offer money to their current customers to close their HELOC accounts when those customers have a zero balance on their HELOC account. These banks would prefer to have customers that do not owe them money now close their accounts, rather than have them draw on their HELOC account and later not have funds to repay the bank.
If you refinance at 5.75 percent, and keep the HELOC, you can always pay off the HELOC balance with your retirement savings after you stop working. If you decide to continue working beyond 70 1/2, when you’re required to begin withdrawals from your 401(k) and other tax-deferred retirement plans, you can use some of that retirement cash to pay off your primary loan and your HELOC as well.
Sept. 25, 2008.