July 19, 2010 in Refinancing

Know your ARM before mortgage refinance

Dear Dr. Don,

I took out a 7/1 interest-only loan in 2005 at a mortgage rate of 4.5 percent. My current monthly payment is $1,833 monthly. Should I refinance now or wait until later?

— John Jump-in

Dear John,

You need to read your loan documents to know what will happen at the end of seven years. How is the new interest rate determined? Is there a balloon payment or does the loan recast as a fully amortizing 23-year mortgage?

Not all 7/1 adjustable-rate mortgages are designed the same. Know your terms and you’ll know better whether to refi now or later.

If you have only been making interest payments, there’s been no reduction in the principal balance on the loan. Thus, your equity in the property is based on your down payment and how the home appraises when you refinance.

Ideally, you have enough equity in the property to refinance without doing a cash-in refinancing. The Bankrate feature “‘Cash-in’ refinance activity skyrockets” has more on that approach to refinancing.

If your $1,833 monthly payment is just interest, and doesn’t include the escrow payment for insurance and taxes, you have a loan balance of about $488,000. That may be above the loan limits for Fannie Mae and Freddie Mac loans in your market.

You can find out the conforming loan limit for your area on Bankrate.com or on the Federal Housing Finance Agency website.

If you live in a high-cost region, you may qualify for a “super conforming loan,” which is different from a jumbo loan. Fannie Mae and Freddie Mac do buy super conforming loans, making it easier to refinance qualifying large mortgages.

If you plan to be in the house long enough to justify the costs of refinancing, and you are able to refinance, I recommend you don’t wait and instead take advantage of today’s low fixed rates. Bankrate’s refinance mortgage calculators can help you get comfortable with this decision.

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