refinance

Weigh interest-only mortgage refinance

Don Taylorq_v2.gifDear Dr. Don,
I've been in my condo for three years and have an interest-only 30-year fixed-rate loan at 7.3 percent. My credit score is 760, but I haven't been able to refinance because my building is not FHA-approved.

I am wondering if I should give up my dream of refinancing and focus on making this loan work. I've heard lately that I can lower how much interest I pay by breaking my payment in two and paying every two weeks. I have the ability to overpay on my monthly payment, but haven't been doing so because I thought I'd be able to refinance out.

How should I make payments so that if I never get out of this loan, I'll pay the least interest? Is refinancing a good option for someone who's paid three years into an interest-only loan? Is it a waste of all I've paid already to refinance, or a good thing? Please help!
-- Jessica Jumpstart

a_v2.gifDear Jessica,
There's no magic in converting your loan to a biweekly mortgage. It's not making a payment every two weeks that drives down the interest expense and shortens the loan term; it's the impact of making the equivalent of 13 mortgage payments a year.

You can do as well by making additional principal payments on the loan, as I point out in more detail in an earlier column, "Use DIY method of extra loan payments."

You can use Bankrate's amortization schedule calculator to see how an additional payment strategy reduces your interest expense and loan term. You can also use Bankrate's biweekly mortgage calculator and compare your results.

Homeowners use interest-only loans for a variety of reasons. During the bull market in stocks in the late 1990s, homeowners justified the decision because they could keep more money invested in the stock market.

In the front half of this decade, homeowners saw their home equity position grow through price appreciation and didn't feel any pressure to pay down the loan on an appreciating asset. Using the lower payment on an interest-only loan to qualify to buy a home was a third reason for the popularity of these loans. 

I don't know which camp you're in, but it's not a waste of all you've already paid in interest expense to refinance your mortgage. You borrowed money for a period of time and paid interest on the loan. That happens with all loans. The difference with your loan is that you aren't currently working toward paying down the loan.

Since financing by the Federal Housing Administration is not currently an option for condos in your building, consider whether refinancing is available through the government's Making Home Affordable program.

Read more about refinance.

Read more Dr. Don columns for additional personal finance advice.

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