Given a choice in this housing market, buying a new house may be a better long term option than refinancing your home into a lower rate mortgage.

Q: My husband and I have approximately $140,000 left on our mortgage with only 7 to 8 years left. It’s a 15-year mortgage with a 5 percent interest rate.

I’ve done the math and it seems that refinancing to a 15-year mortgage at 3.3 percent could save us $18,000 in interest, less the refinance costs. We’re also thinking about doing a 5/1 adjustable rate mortgage (ARM) that would be closer to 3 percent.

Alternatively, we would like to move into a larger house to take advantage of the low interest rates and improve our tax deductions, but are concerned about jumping into this market.

Our current house could sell for about $500,000 in the Washington DC area. Some homes are priced from about $600,000 to $800,000 in our area. We are unsure of the added costs of owning a larger home with two children approaching college.

Together we net about $10,000 per month. Do you have thoughts on the better course of action in this market?

A: Let’s tackle each of your questions separately. The first question is should you actually refinance? One advantage you have is you seem to have plenty of equity in your home and shouldn’t have to worry about an appraisal coming in too low for your refinance. What you still owe on your loan is a small percentage of what you believe your home is worth.

You’re about half way into paying off your loan and about half of each monthly payment is going towards interest and half going towards principal. If you take out a new loan, especially one that is amortized over 30 years, your payment in the early years will be made up mostly interest payments. While your monthly payment will be less, you will add years of payments to your loan.

However, if you’re thinking of taking out a 5-year adjustable rate loan (an ARM loan that would be fixed for five years and then convert to a yearly adjustable loan), but would make the same payment you have been making all along, you might be very close to paying off the loan at the end of the 5-year fixed interest rate period.

Keep in mind that your interest rate could increase significantly during that sixth year of the loan, but if you have paid down the loan significantly, you may not owe too much and the increase in the rate may not affect you all that much.
If you think you can swing the higher payments and can get close to paying off your debt in six or seven years from now, your idea of refinancing to a five year adjustable mortgage might just pay off.

Your second question is a more personal question and it involves emotional and personal issues. Whether you need or want a larger home is a personal decision only you can make. If you’ve decided to take that leap and move forward to buy a larger home, in some markets your timing couldn’t be better.

But you said that you live in the Washington, DC area and that market hasn’t seen the same decline in value as in Phoenix, Miami, Las Vegas or even Chicago. That’s good news for you as a seller, but you won’t get as amazing a deal as a buyer.

You’ll have to gauge for yourself whether home prices in your neighborhood are a good value. You certainly know that interest rates are a great deal these days, but unless you have sizeable savings, you will have to increase your borrowing substantially to buy a larger home.

Are you ready to take on a lot more debt? With two kids approaching college, your finances will be very dependent on what type of loan programs and financial aid packages each of your children obtain from the college of their choice. Are you saving for college and your retirement? Given what you earn on a monthly basis, you and your kids may obtain some limited help from colleges and you may find that you’ll need the extra money to pay for their education.

While you are thinking of possibly buying a larger home, many people in your shoes would be thinking of downsizing just as their kids are off to college. Given the prospect that annual costs at some colleges is now approaching $60,000 and you have two kids to put through college, you’ll have to evaluate what you have saved for their education, what you think you might get in college aid and loans, what your cash flow will be like while they are at school.

And be sure to take a look at whether you and your spouse have saved enough for retirement.

We’re in the same boat. Our kids are approaching college and we’re somewhat horrified at the prospect of spending $100,000 per year on their college educations. Instead of trading up, we’ve opted to refinance our home to another 15-year loan, at an interest rate of less than 3.5 percent, and are always looking for ways to save more money for those upcoming tuition bills and our eventual retirement.