 Pay
prepayment penalty or wait out rates?
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 Dear
Dr. Don,
In the current market, would it be smarter to refinance my ARM mortgage
and pay a $5,200 prepayment penalty along with approximately $3,300
in closing costs in favor of a conventional mortgage at 6 percent
or 6.25 percent?
The ARM is based on the monthly average of three-month CDs plus
a 3.65 percent margin, and the past few months have thrown me in
negative amortization. My current APR is hovering around 6.5 percent
to 6.7 percent.
-- Michelle Mortgage
 Dear
Michelle,
I'm having a hard time recommending that you spend $8,500 to refinance
your existing mortgage to avoid the interest rate risk inherent
in an adjustable-rate mortgage.
How long do you plan to stay in the house? How long
until the prepayment penalty drops off? If you don't plan on being
in the house for more than a few years, then taking on this expense
doesn't make much sense. If the prepayment penalty drops off in
a year or two, it may make sense to wait it out. You'll have the
closing cost expense no matter when you refinance, so what's key
here is whether it makes sense to refinance when you are also subject
to a prepayment penalty.
Although I can't say it with certainty, the Federal Reserve appears
to be within a few rate increases of the end of increasing its targeted
federal funds rate.
Increases in that short-term rate put upward pressure on other
short-term interest rates, including three-month certificates of
deposit, or CDs, so the upward pressure on short-term interest rates
might be almost over. Bankrate's weekly rate
trend indexes for both the mortgage and the CD market let you
know where the experts think rates are headed.
Since your adjustable-rate mortgage is priced based on a three-month
CD index, both rate trend indexes can keep your finger on the pulse
of the market. Bankrate doesn't track your CD index on its Rate
Watch page, so you'll have to find a source for that index.
Federal Reserve Statistical
Release H.15 Selected Interest Rates may serve as a reasonable
proxy for that index.
Jack Guttentag, the mortgage professor, has a mortgage refinancing
calculator
that looks at refinancing an ARM with a fixed rate mortgage, given
estimates of how long you plan on staying in the house and what
you think may happen to the interest rates.
The negative amortization just reflects the fact that your current
monthly mortgage payment doesn't fully cover the interest expense.
The unpaid interest expense is added to your mortgage balance. If
your monthly mortgage payment isn't covering your interest expense,
and you don't want to experience negative amortization, you have
to make an additional payment to cover that expense.
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