You took out an interest only home loan because the payments were more affordable or the interest rate was exceptionally low. It’s been a few years and now you wonder what you should do? Should you refinance the interest only loan or leave it alone? The answer is one of personal preference, but there are some serious considerations to make.
Why did you Take an Interest Only Home Loan?
The first thing to consider is why you took the interest only home loan. Was it because you could not afford any other payment? Or was it because you liked the interest rate of this particular loan at the time? What would you benefit by refinancing today? These are a few questions to ponder.
Some people took the interest only loan because they did not have the money to pay the principal back. The low payment sounded intriguing so they jumped on it. Since it’s been a few years and the interest-only component of the loan is about to expire, they need to figure out what to do. Should you refinance into a standard fixed rate loan, take an adjustable rate loan or just let the loan reset? If you cannot afford any of these options, you might have to sell the home. If you fell into the trap of taking a loan you could only afford with interest-only payments, you might have to figure out what your next step will be to make things work.
The answer really depends on what your current financial situation looks like. Can you afford fully amortized principal and interest payments as the loan is right now? You should know the amount of the payment because the lender had to include it in your closing documents. How does the interest rate you pay compare to the interest rates today? Would you save money by refinancing? If so, the answer is clear. Since you did not pay any principal down on the loan yet, you will not lose anything you have invested in the home. You are not starting over either, since your interest only loan is like starting all over again anyways.
If you cannot afford the full amortized payments, you might have to consider an ARM. These loans usually provide you with a lower introductory rate for 3-5 years. You pay principal on these loans, but the interest rates are lower so hopefully the fully amortized payment will be affordable for you. In addition, you can reset the loan for another 30 years as opposed to the remaining years on the term of your current loan. Most interest-only loans have an interest-only period of 10 years with 20 years to pay the principal off. This results in a higher principal payment, which may not be affordable for you right now.
How Long will you Stay in the Home?
Another consideration to make when deciding if you should refinance your interest only loan is how long you plan to stay in the home. If you know you plan to move in the next 6 to 12 months, refinancing might not make sense. If you can pull off the fully amortized payment of your current mortgage, make those payments in the short term while you get your home ready to sell. If you choose to refinance, make sure the new loan does not make you lose money on the deal. Remember, you may not be in the home long enough to hit the break-even point after paying closing costs.
What do you do with the Extra Money?
Some people take interest-only home loans strictly because they have something to do with the money they would pay towards the principal. Maybe you pay for a child in college or you have an expensive car payment. If this is the case for you, it is time to reevaluate your finances. You have to prioritize what is right and forgo the more expensive payments. If this means getting rid of your expensive car so you can pay your mortgage, then you have no choice unless you want to sell your home.
If this is the case for you, choosing the time to refinance is up to you. If you have to sell your car or find another way to pay your child’s college tuition, you might want to refinance sooner rather than later. This way you could start saving money right away and might be able to avoid the unpleasantness of selling your car or finding alternative ways to pay for college.
The right time to refinance your interest only home loan really depends on the factors surrounding your loan. If you took it because you could not afford anything else, you could be in over your head. The good news is there are many options available to you today. Talk to several lenders to see what you can do. If you have good credit, a low debt ratio and steady employment, you should have several loan options at your disposal including conventional and FHA loans. If you have a few flaws in your mortgage application, many subprime or alternative documentation lenders keep loans on their own portfolio and may be able to help you. The key is to shop around and figure out all of your options before making a decision. Your ultimate goal is probably to save your home, so keep this in mind as you shop around.
