mortgage

Homeowner frets over interest-only loan

Don Taylorq_v2.gifDear Dr. Don,
I am on a five-year, interest-only adjustable-rate mortgage at 5.25 percent that will adjust in May at the 12-month LIBOR rate, plus 2.25 points. I cannot afford my payment going up hundreds of dollars. What should I do? Does the new stimulus help me? I am current on my mortgage.
-- Linda Leverage

a_v2.gifDear Linda,
You can track most of the interest rates, including 12-month LIBOR, that are used to price adjustable-rate mortgages, or ARMs, on Bankrate using its "Rate Watch: Track leading interest rates" feature.

The 12-month LIBOR rate is currently 2.12 percent. Using this rate and adding the pricing spread of 2.25 points would put have your mortgage reset at 4.37 percent.

Now, a lot can happen between today and May, when the mortgage actually resets. But it doesn't look like you face much risk of higher interest rates on the upcoming rate reset.

A payment increase is more likely to come about because the loan is structured to switch from interest-only payment to an amortized loan payment. A quick review of your loan documents, or a call to your lender, can confirm the changeover from interest only to an amortized loan.

If that is the case, it would be common for the outstanding loan balance to be amortized over a 25-year term. You can calculate the size of the payment using Bankrate's Mortgage payment calculator.

Should you refinance? If you can't afford a 25-year amortization and you plan on staying in the house, it makes sense to refinance into a new 30-year fixed-rate amortized loan. On the other hand, a new 5/1 ARM could make sense if you don't think you'll be in the house for many years.

The table below uses Bankrate's mortgage payment calculator and its interest-only calculator to show you the difference in payments, using the example of a $200,000 mortgage at current interest rates.

Payments for two scenarios
Interest-only LIBOR ARM*Amortized
LIBOR ARM*
Amortized 30-year fixed
Loan amount:$200,000$200,000$200,000
Interest rate:4.37%4.37%5.41%
Loan term months:n/a300360
Loan payment:$728.33$1,096.96$1,124.31
*Assumes ARM interest rate stays constant over the loan term.

You don't say whether you're upside down in the mortgage -- that is, you owe more on the loan than the home is worth. I sure hope that housing prices in your market haven't fallen so much over the past five years that your home is now worth less than the loan balance.

I don't see the provisions of the stimulus package helping you, although you can find out for sure by reading the Bankrate feature "What the Obama housing plan will, won't do."

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