Another refinance question

[all4money]

Hey, guys. A friend has asked me this question and I really don't know what to tell them... what are your thoughts?

Aug 2006, got a 2/1 yr ARM at 6.25%
Aug 2008 will adjust down the 1% max to 5.25%

OR the same bank has a program to where they will modify the existing loan to the current new rate offered which is 4.25%. There are no costs except for the following: A modification fee of .75% of the outstanding loan balance will be added to the principal balance of the loan.
Everything else about the loan remains the same, just the rate changes. No application, appraisals, closing costs, etc.

So, should he hang on until the loan adjusts itself down the 1% or should he modify the rate as offered? He said he's planning on being in the house for another year or two...

[noppenbd]

Interesting. How often does the current 5.25% loan adjust, and what are the terms of the new 4.25 loan (2/1 ARM?, rate formula, etc)?

[jIM_Ohio]

What is the mortgage balance?

I would say NO, just refinance and get a 10/1 ARM, 15 yr fixed or 30 yr fixed, or keep current loan if staying in house less than 10 years.

Lock in a rate when they are lowest.

[all4money]

mortgage balance is $280K

The loan is set up to adjust every 2 years with a maximum adjustment of 1% up or down. The "new" loan is the exact same loan with the same terms... it's not considered a refinance because they can't get any cash out or redo the loan amount at all. The only thing that changes is the interest rate. It's just a feature that the bank offers so that their clients can adjust the rate more than the 1% for situations like this when the market changes so dramatically. I guess the question will be if the .75% (which is about $2,100) tacked onto the principal balance will be offset by the savings of a 2% rate reduction (from 6.25% to 4.25%), or is that even a consideration if he doesn't plan to be there for many more years...?

[all4money]

Originally Posted by jIM_Ohio

What is the mortgage balance?

I would say NO, just refinance and get a 10/1 ARM, 15 yr fixed or 30 yr fixed, or keep current loan if staying in house less than 10 years.

Lock in a rate when they are lowest.

Would the cost of a full refinance be worth it if they won't be staying there many more years?

[jIM_Ohio]

Originally Posted by all4money

Would the cost of a full refinance be worth it if they won't be staying there many more years?

that is why I added

or keep current loan if staying in house less than 10 years.

[noppenbd]

Assuming he is definitely moving in 1-2 years, and if the choices are:

1) Allow rate to float to 5.25% and pay nothing extra.
2) Bump rate to 4.25% and pay 0.75 pts.

Then #2 is mathematically better. With #1 you are paying 1% more interest each year ($2800) for 2 years, versus #2, adding $2100 to the loan.

This is assuming that otherwise the 2 loans are identical (both float the rate every 2 years).

That said, I generally detest ARMs because you never really know if you will be able to move in 2 years (will the market recover, financial situation changes, etc).

[jIM_Ohio]

Originally Posted by all4money

mortgage balance is $280K

The loan is set up to adjust every 2 years with a maximum adjustment of 1% up or down. The "new" loan is the exact same loan with the same terms... it's not considered a refinance because they can't get any cash out or redo the loan amount at all. The only thing that changes is the interest rate. It's just a feature that the bank offers so that their clients can adjust the rate more than the 1% for situations like this when the market changes so dramatically. I guess the question will be if the .75% (which is about $2,100) tacked onto the principal balance will be offset by the savings of a 2% rate reduction (from 6.25% to 4.25%), or is that even a consideration if he doesn't plan to be there for many more years...?

If you can pay $2100 to principal now, would you?

I think this is a bad deal. You pay $2100 to get a lower payment for 2 years.
Then in 2 years the rate adjusts again. Would you then pay $2000 to reset the interest rate again?
4 years later would you pay $1900 to do same thing again.
Good deal for bank, bad deal for you.

My advice would be to pay down the loan or get out of the loan within 10 years. If you move in less than 10, good enough. If you refinance out, good move too.

I might even move the over/under from 10 years to 5 years.

[jIM_Ohio]

Originally Posted by noppenbd

Assuming he is definitely moving in 1-2 years, and if the choices are:

1) Allow rate to float to 5.25% and pay nothing extra.
2) Bump rate to 4.25% and pay 0.75 pts.

Then #2 is mathematically better. With #1 you are paying 1% more interest each year ($2800) for 2 years, versus #2, adding $2100 to the loan.

This is assuming that otherwise the 2 loans are identical (both float the rate every 2 years).

That said, I generally detest ARMs because you never really know if you will be able to move in 2 years (will the market recover, financial situation changes, etc).

Agree on the math, but that $2800 needs to be looked at from two sides

It is only $2100 after taxes
If he could apply $2800 to pay down principal, what would the effective payment change or interest rate be? He does not have the $2800, so the principal balance goes up. Might save on interest, but it might extend the term more than needed. Not sure how to run that- it would be a complex ammortization table.

[noppenbd]

Assuming term stays the same (I read his post that it does), here are the 2 scenarios, simplifying by assuming rate of 5.25 is effective today:

1) Stick with current loan. P&I of 1546 a month, pays principal down to 271900 over 2 years, meanwhile pays 29K interest
2) Modify loan, get 4.25%, add 2100 to principal. P&I goes to 1388 a month, pays principal down to 272300 over 2 years, meanwhile pays 23.6K interest.

Seems like #2 is a clear winner. Principal is only $400 higher and saves 5400 in interest (maybe pocketing 3600 or so after taxes).

[all4money]

Yes, everything stays the same... the loan term doesn't get extended at all. Same loan, just a lowered rate with the $2100 added onto the principal.

Thanks for all the input so far...

[Brokemofo]

Originally Posted by all4money

Hey, guys. A friend has asked me this question and I really don't know what to tell them... what are your thoughts?

Aug 2006, got a 2/1 yr ARM at 6.25%
Aug 2008 will adjust down the 1% max to 5.25%

OR the same bank has a program to where they will modify the existing loan to the current new rate offered which is 4.25%. There are no costs except for the following: A modification fee of .75% of the outstanding loan balance will be added to the principal balance of the loan.
Everything else about the loan remains the same, just the rate changes. No application, appraisals, closing costs, etc.

So, should he hang on until the loan adjusts itself down the 1% or should he modify the rate as offered? He said he's planning on being in the house for another year or two...

If they have a 2/1 arm, how do they know what the rate will be in August? How do they know it will go down 1%?

I would leave it all alone since they plan to move in a year of so.

[jIM_Ohio]

In this market I would be skeptical of any plan which added money to my principal.

If the house was 100% financed and $2100 is added to the principal of loan, the OP owes more money than house is worth.

I am not familiar with ARMs. Do they pay down principal or are they interest only? If the loan is not paying down principal, and the house does not appreciate 2k every 2 years, I see this as a bad deal in todays RE market.

[Brokemofo]

ARM's do pay off principal, unless you have a interest only version. ARM's have an initial rate, subsequent rate, and a lifetime cap rate. A 2/1 like the OP is speaking about is fixed for 2 years then adjusts every year after that by up to 1%. There should also be a lifetime cap not mentioned by the OP.

[jfjdog]

I would definitely refinance. I am in the same boat except my original rate was 5.75 and the 2 yr term is up in July. I have the same exact option to modify for .75% of loan balance to bring rate to 4.25%. I was just looking into this today for the first time which lead me to this site.

In his case, if he is fairly sure that he will be there for 2 more years and he modifies asap, he will save by dropping his rate by 2% (6.25 less 4.25) for April, May, June, and July and then 1% (5.25 less 4.25) for the next 20 months. He will save roughly 6,500 in interest for a fee of 2,100, meaning he net saves approx 4,400 by modifying.

[safari]

I recommend refinancing to 5/1 ARM with ING Direct at 5.25%. There are no points to pay and the closing costs are very low compared to other banks. Here is the link.