Help a Reader: Calculating Loan Options

Here's a recent request I received from a reader:

Currently, I have a loan where the original loan amount is for 204,500 with a 4.75% ARM for 5 years.  Since September 2004 when we bought the home, I have knocked the principle down to 158,500 and I estimated that by the end of the ARM in about 1.5 years, I will have the principle down to 141k.  At that time the loan could potentially jump up by 2% and than 1% a year after that to, I think, 12%.

How do I calculate whether it is better to stick with the current loan now with the possibility of the rate jumping way up or to refinance now while the rates are low with either another ARM or 15 year mortgage on the current principle, 158k?  Because home loans are not simple interest I am having a hard time calculating whether it's better to have a smaller loan (158k) on a 15/30 term or my current term where more money is finally going towards principle since I paid the principle down.

Do you have any advice for him?

Comments

[Tim]

In my opinion, unless you plan to move in the next year, you should refinance to a 15 year mortgage NOW. This is a no-brainer.

I'm also looking at refinancing from my 30 year mortgage to a 15 year mortgage. Interest rates on the 15 year with no points are at 5%-5.25%. Don't wait until your ARM resets because your personal circumstances could change by then (loss of income) and you might not have an option to refinance due to the tightening loan requirements. Plus rates now are very low and there is no guarantee they will stay this low.

To answer you question directly, you could just run your 5 year arm through an amortization schedule and calculate the interest you will pay now until the loan resets. Then just take the remaining principle and run a new amortization schedule at an estimated adjusted rate (be conservative here). Add up all the interest until the loan is paid off. Compare the total interest paid on your current loan with a new loan. I would use 5.25% on a 15 year loan. Be sure to add at least $2500 to your principle balance to cover closing costs you will need to pay to refinance. Bankrate.com has an amortization calculator.

Tim

[Nathan]

I agree with Tim, this is really a no-brainer, but I went ahead and did the calculations.

I have a spreadsheet that I use to visualize amortization of loans (which I'll share later today). Using this and the information given, I came up with an estimated current payment of $1,566.83 with a total interest paid, starting from now, of $119,370.21. Putting the appropriate rate for a no closing cost 15 year mortgage (5.944%) from my bank (Eastman Savings & Loan), I came up with a payment of about $1328.19 with a total interest of $81,900.71, a 31.4% savings. Combine the fixed rate with the original payment and you get $61,984.15 in interest, a whopping 48.1% savings.

Your results may vary from the model.

[CommRE]

I was in almost the exact same situation and here is what I did (maybe not best for you). My original balance of $242,500 5/1 ARM at 4.75% resets in 15 months at LIBOR + 2.625, max of 2% adjustment. Currently owe $227,000. I was all set to get a 15yr fixed a few weeks ago, but by the time I processed my paperwork with my no-closing cost lender, ARMs had actually dropped below the 15 yr rate.

Since we are moving in 4-5 years, I went ahead and got another 5/1 30 year ARM at 5.125%, but am paying extra principal by making the same monthly payment as I would on a 15 yr fixed. About another $600/month. When I sell, that will get me to a lower balance than I would have with the 15 yr fixed since the interest rate is lower.

[Mark]

I would definitely refinance to get a fixed rate at 15-20 years. However, I would stop making extra principal payments once you reach the 25% equity point in the present market value of your home. If you had put money down in the beginning, I'm assuming you are now around 35-45% equity. If you have been making extra principal payments all this time, you obviously don't have a cash flow problem. I would NOT suggest a No Closing Cost Loan as the fees are just added to the principal and the interest rate is higher. Take those extra principal payments and invest in your retirement portfolio, or do some home improvement to raise the value of your home. With a fixed 20-year mortgage, you get a decent amount of principal payment with a respectable amount of deductible interest.

[coast trash]

The bottom line is whether you plan to be in the house for more than the next 1.5 years. If so, refinance into a 15 or 30 year fixed. The refinance charges will be paid off shortly after that.

[CommRE]

"I would NOT suggest a No Closing Cost Loan as the fees are just added to the principal and the interest rate is higher. "

Actually, I made sure to compare the slightly lower rate and higher closing cost of another loan. The APR was better on the no-closing cost loan. In all honesty, the difference was minimal, but I'll take the better deal every time.

[JACK]

Haven't checked in a while, but the best calculators out there I know of for mortgages are http://www.mtgprofessor.com/calculators.htm

[Jules]

Thank you Jack. Great calculator. I'm getting ready to up the extra amount I have applied to principal, but couldn't find a calculator that calculated changes in the middle of a loan. This one did it - very helpful.

Jules