Refinance or relocate? Ask Dr. Don by Don Taylor, Ph.D., CFA, CFP • Bankrate.com

Hi Dr. Don,
For the past five years we have been making only interest payments on our mortgage loan. We were recently contacted by a company that assures us we can pay off our credit cards and lower our monthly payments on our house at the same time?

Is this possible, or is it a mistake? I think selling the house and making a profit would be the way to go but my spouse thinks otherwise.
Thanks
-- Debbie Debates

Dear Debbie,
Refinancing now will start the clock over on a 30-year loan. Over the last five years the home may have increased enough in value to let you do a cash-out refinancing to pay off the credit card bills, and the longer loan maturity at today's good mortgage rates leaves you with a lower monthly payment than you have on your existing mortgage.

Selling the house, using the profits to pay off your debts and moving into another home is always an option, but you're paying a pretty steep price in taking that route. Between real estate commissions, moving expenses, closing costs and redecorating the new place, you could spend a sum that could dwarf your outstanding credit card debt.

With an interest-only loan you've kept mortgage payments about as low as they can get without negative amortization on the loan. If you were in a 5/1 interest-only adjustable-rate mortgage, or ARM, and you're facing the first interest rate adjustment after five years, I can understand why you're looking for alternatives to your current loan.

The Bankrate national average for a 30-year, fixed-rate loan is 6.31 percent at the time of this writing. The national average for a 5/1 ARM is 6.06. Although that statistic isn't for an interest-only 5/1 ARM, my expectation is that it is a pretty close estimate for the interest-only note. To me the difference between the two rates isn't large enough to take on the interest rate risk in the interest-only 5/1 ARM.

Interest rates on a $200,000 home

5/1 interest only ARM Conventional 30-year fixed Difference Loan amount:  $200,000 $200,000   Interest rate: 6.06% 6.31%   Monthly payment: $1,010 $1,239 $(229) Five years of payments: $60,600 $74,355 $(13,755) Loan balance after 5 years: $200,000 $186,808 $13,192 Total interest expense: $60,600.00 $61,162.50 $(563)

The table above shows how, with the above interest rates on a $200,000 home, you reduce your monthly payment by $229 by using the 5/1 interest-only ARM but after five years the loan balance on the 5/1 ARM is $13,192 more than the balance on the fixed rate loan. You can use Bankrate's mortgage payment calculator to create a table specific to your situation.

The problem with using cash-out refinancing to pay off your credit card debts is that you run the risk of racking up your credit card balances all over again. You're also using 30-year financing to pay off past purchases. Even with lower interest rates you can wind up spending more in interest expense than you would if you just took an aggressive approach to paying down the credit card debt.

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