Dear Dr. Don,
I owe $750,000 on my mortgage. The house is currently appraised at about $700,000 (based on a purchase price of $825,000 six years ago). My interest rate resets annually at the one-year Treasury rate, plus 2.75 points. For the next year, the interest rate is 3.125 percent. The maximum rate the loan can reset at each year is 9 percent. I have about $700,000 in cash, as well as about $600,000 in retirement funds. My annual salary is around $400,000 and I anticipate working for another 10 years, if not more.
I like my home and would prefer not to move, but given the uncertainty in the market, I can't anticipate how interest rates will impact my mortgage each year. What would you suggest?
-- Adam Adjusts
It's pretty clear the Federal Reserve Board isn't in a hurry to start increasing its targeted federal funds rate, which should keep the one-year Treasury rate low over the next year or two. However, fixed-rate mortgages are priced off the yield on the 10-year Treasury note, and the yield on that security has started to head higher.
Mortgage rates today are low. As I write this, the Bankrate national average for a 30-year fixed-rate loan is 5.21 percent. That's a great rate, and it's likely to be much lower now than it will be a year from now.
You have enough financial flexibility that you could refinance your existing loan by tapping your savings to increase your equity in the home. Assuming your appraised value is correct, you'd need to tap $190,000 in savings to get to an 80 percent loan-to-value on a $700,000 home. That would mean a $560,000 mortgage.
Whether this loan would be considered a nonconforming, or jumbo, loan would depend on where you live. You can find the loan limits for conforming loans in your location on the Federal Housing Finance Agency Web page "Conforming Loan Limit."
The other way to look at this is that you have the financial flexibility to handle the interest rate risk. The interest savings from the lower rate on your adjustable-rate mortgage -- combined with not having to pay closing costs on a new first mortgage and not tapping into your savings -- would let you save thousands in interest expense over the next one to three years. You could choose to use this savings to pay down your existing mortgage.
It comes down to the "sleep test." If the worry of rising mortgage interest rates has you anxious and losing sleep, you're going to be more comfortable in a fixed-rate mortgage. In that case, you're better off getting a home refinance now rather than later. If you can't see tapping your savings in order to get a fixed-rate mortgage at a rate more than 2 percent higher than the current rate on your ARM, then stand pat.
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