Dear Dr. Don,
I am currently in the home improvement contract phase with an estimated $72,000 kitchen/bathroom project at hand and am wondering about the wisdom of a mortgage refinance.

I purchased my home in 2005 for $350,000 with a $100,000 down payment. I financed the remaining amount with a 5.25 percent 10-year interest-only adjustable-rate mortgage. I have a credit rating of 780 and diligently pay an extra $720 each month toward the principal. To date, my payoff stands at $220,000.

Although I have sufficient funds in savings to finance the entire project, I am choosing to use the home’s equity instead. Now that I am five years into the 10-year ARM, I am considering a 15-year refinance with an equity cash-out.

Is this the best option versus taking out a home equity loan to finance my project? I am planning on residing in this home at least 20 more years, so there is plenty of time to recoup the associated expenses surrounding these options. However, the bank will only loan 80 percent on the value of the home, which presently is appraising at approximately $350,000. Any advice as to the logical decision?
— Mike Mortises

Dear Mike,
There’s quite a difference when making a mortgage comparison between the monthly payments on a 10-year interest-only ARM and a 15-year fixed-rate mortgage — especially when you’re bumping the loan balance from $220,000 to $280,000. The monthly payment will jump from $962.50 to $2,144.84, using the current national average mortgage rate for a 15-year fixed-rate mortgage of 4.52 percent.

Admittedly, you’ve been making additional principal payments of $720 a month, but even with that you’re increasing your monthly nut by $462.34.

The $280,000 number came from multiplying the appraised value ($350,000) by the bank’s 80 percent loan-to-value limit. You’d need to liquidate $12,000 in savings, plus closing costs, to cover the $72,000 estimated cost of the project.

The cash-out mortgage refi option is appealing because you plan to be in the house for a long period of time. Five years from now, I don’t think you’re going to like what happens to your existing mortgage; or if you refinance then, the new interest rate on your loan.

Using a home equity line or loan now to finance the remodel won’t change the interest rate issue on your first mortgage. You’d also add the potential drama of the second mortgage creating credit issues when you later decide to refinance the first mortgage.

I think you should also consider how much financial flexibility you have in your monthly household budget. If it’s not a lot, look at a 20-year or 30-year fixed-rate mortgage versus a 15-year mortgage. To date, you’ve shown the financial discipline to pay down your interest-only mortgage voluntarily on an aggressive schedule, but a 15-year fixed-rate mortgage will make those large payments contractual.

A refinance with a 15-year fixed-rate mortgage gets you a lower mortgage rate — 4.52 percent versus 5.15 percent, based on national averages — and you’ll pay a lot less in interest expense. But you’ll also have much less financial flexibility if you choose this mortgage refi path.

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