Q: I have a 15-year mortgage on my home that is at 5.875 percent. The balance is at $80,000. It will be paid off in six years.
Facing a very difficult financial situation, we took out a home equity line of credit which now has a balance of $282,000. The interest rate on this loan is prime minus .25 percent.
We opened the line of credit in July, 2006 and the first ten years we pay only the interest. After that, we pay down interest and principal for 20 years until the loan is paid off.
Even after the last two years of home prices declining in our neighborhood, our home’s value is approximately $450,000. There is a possibility we could sell in the next few years.
I had applied to refinance our 15-year mortgage with the lower interest rates but after reading your stories, I think I should leave that mortgage as is. The question is what I should do for our home equity line of credit.
Our credit scores are in the mid to upper 600’s.
A: You’re probably right to leave your first mortgage alone. If you try to refinance the home equity and first mortgage together, you’ll need to get a loan for about $365,000. Depending on where your home appraises out in value, there’s a chance you could wind up paying private mortgage insurance, which would increase your monthly payments. Plus, you’d have to shell out several thousand dollars (or more) to refinance.
Currently, your rate on your equity line of credit is about 3 percent – a rate that is extremely low. While you could get a lower rate on a new 15-year loan, you’re basically paying no interest on that loan now. In the last years of a loan, each of your monthly payments will consist of mostly principal and little interest.
You’re far better off throwing cash at your 15-year loan with the hopes of paying it off sooner (see below). Your -.25 percent rate on your home equity line is excellent. That rate should stay low for at least a little while, giving you a chance to make a smart move.
I think what you need to do is figure out how you’re going to pay off the first loan by 2016, when you’re going to have to start paying principal and interest payments on the home equity line of credit. If you’re finished paying off that 15-year loan, you’ll be able to devote all of those payments plus the interest payments you’ve been making to the second line of credit, and hopefully get that loan paid off or paid down fairly quickly.
If your fortunes have improved enough, you should throw everything you have at the 15-year mortgage, since you only have 6 years left and you’ve already paid off most of the interest on that loan. Shaving a year or two (i.e. paying it off in 2016 or even 2015) will be psychologically important and help you get over the hurdle of paying two mortgages for one year.
Also, if you can get that loan paid down, you might then be able to refinance before rates rise to a new 15-year or 30-year loan that includes paying off the home equity line of credit. While you might be paying a little more initially with the HELOC, if interest rates rise substantially, you might find that locking in at a low rate now is a good long-term move – especially if you’ll need 20 years to pay off that loan.
If you decide to move, you’ll be much better off getting rid of one of those mortgages and having a substantial amount of equity in hand to purchase something new. You might even be able to use your equity to pay for most of your new home in cash, which I’m sure would be a welcome change from being under the weight of these two mortgage decisions you made.
One important question you must ask yourself is whether the monthly payments you now make work well in your budget and whether the new payment you might have to make if you had to pay principal and interest on your equity line would be within your means. If you can afford both loans and your only issue is whether you should refinance or not, that decision will depend on when you plan to move and sell the home and where you think interest rates are going.
If you plan to move in the next couple of years, it may not benefit you to try to do anything with your loans. The rates you currently have are great and you will reap the benefit of those low rates for the time to come.
If you plan to be at the home for a while, you should take a look at the terms of your equity line and see when the rate changes. The rate may change once per year or every time rates change. In some cases, you may have rate caps on the loan. That means your interest rate can’t go higher than a certain amount. You need to know what your downside is with this loan before deciding what to do if you know you’ll be at the home for the next five to seven years.
Take out a piece of paper and pencil and run down the options of what would happen to your monthly home equity line of credit payments if interest rates rise over then next several years. If you know your downside and you have an idea of how long you plan to stay in the home, you’ll be better able to decide whether you should refinance now or keep your loans as they are.
I hope this helps provide some additional guidance. Hang in there – you can make this work.
Good luck, and happy holidays.