Q: Twenty-one months ago my husband and I refinanced our home loan. At that time our plans were to stay in the area up to another two years, so we agreed to an interest-only loan at 6.5 percent, a good rate at the time.
It looks now as though we’ll stay here at least another year, so I’m wondering how to handle our monthly mortgage payments. Our loan allows us to prepay any amount we want toward the principal in addition to our monthly interest payment.
Should we refinance this mortgage? Is it wise to send extra money towards the principal in this situation, or should we just continue to make the required interest-only mortgage payment? Thanks for any time and consideration you give to this query!
A: Interest only loans were quite popular during the past several years and were probably a good choice for those homeowners who did not intend to live in a particular home for a lengthy period of time.
With an interest-only loan, you never paid off any of the debt owed on the home. You simply paid interest on the loan. If your loan was for $200,000 and you sold the home three years later, you still owed the bank $200,000.
If you were thinking about refinancing the loan, the real issue would be to determine what has happened to the value of your property over the past 21 months. If the property has fallen 10 percent in value and you don’t have any equity in the property, then you could only refinance the loan by coming to the closing table with a fat stack of cash in hand.
If, however, you have plenty of equity in the property and simply chose an interest-only loan in order to conserve your cash flow each month, then you should be fine if you were to refinance now or when you sell a year or two down the line and there isn’t a compelling reason to pay any more toward your balance.
Figuring out whether you have equity, and if not, how you’re going to find the cash you need to balance everything out at the closing table should be where you turn your focus.
But whether or not you have equity, I don’t see the need to send extra cash to pay down the principal balance of the mortgage at this time. Your payment to the lender at this time may not reduce your monthly payments much, if any. And money for the prepayment on your mortgage may be better saved or invested elsewhere.
These days, cash is king. If you believe that you can do better by prepaying the mortgage at 6.5 percent interest rather than stashing it into a savings account where you would only earn a tiny amount of interest, then that makes some sense.
But you need to make sure you have sufficient savings on hand these days in case you need the money. Once you pay your lender the money, you won’t be able to ask for it back
If you believe you will stay in this home for 5 to 10 years, rather than just one more year as you expect, you should think about refinancing into a 15 or 30-year loan with a low fixed interest rate.