||Ask Dr. Don
Dear Dr. Don,
I currently have a 30-year fixed-rate mortgage
at 6.875 percent and variable-rate home equity line at 7.55 percent.
I have been paying on the mortgages for two years. I owe $155,000
on the 30-year mortgage and $21,000 on the equity line. My payments
are $1,051 for the mortgage and $325 for the equity line. Is a variable
rate or interest-only loan a good choice for me?
Seeing mortgage rates go higher over the past few months has
people trying to finesse new financings to get mortgage payments
comparable to the lows of this spring. Taking on interest-rate risk
and hoping that the Fed will keep the fed funds rate low, allowing
other short-term rates to remain low, is mostly wistful thinking.
So is not making principal payments by using an interest-only loan.
A variable-rate mortgage is priced at a spread to
an interest rate such as the 11th District Cost of Funds, or the
one-year Treasury Constant Maturity. (Use Bankrate's Rate
Watch feature to follow changes in these rates.) The rate resets
periodically adjusting to changes in the underlying interest rate.
The homeowner takes on the risk that his mortgage rate will increase
over time. Since the homeowner shoulders this risk, the bank doesn't
have to try and price this risk in the mortgage rate.
Variable rates work best when short-term interest
rates are expected to stay the same or go lower. A lower interest
rate on your mortgage means that more of your monthly payment goes
toward principal repayment. A lower monthly payment can also free
up enough money in your budget to make additional principal payments.
An interest-only loan reduces the required monthly
payment by taking out the principal component. You can qualify to
buy a more expensive home because of the lower front-end ration.
This type of mortgage is used when you're not interested
in increasing your equity in the home beyond your down payment and
any increase in the home's market value over time, or you want to
stretch to buy a bigger home than you can currently afford but expect
your annual income to increase over time to the point where you
will be able to pay down the principal on the home. It's also useful
for people who get a high percentage of their annual incomes as
bonuses or in commissions. This
Bankrate feature has more information about interest-only mortgages.
The longer you expect to be living in the house, the
more sense it makes to have a fixed-rate first mortgage. Bankrate
has a mortgage
adviser function that can help you determine if a fixed-rate
or variable-rate mortgage is right for you.
I'm a little perplexed why the variable rate on your
home equity line is so high. Take a look at your loan documents
and see how that rate resets. Depending on the strength of your
credit report and the prepayment provisions on this loan, you may
be able to do much better by refinancing this loan at fairly modest
-- Posted: Sept. 16, 2003