Smart Borrower Center
Tools to help you borrow better
Three years ago, Paul and Lisa (not their real names) fell in love with a four-bedroom house in a leafy neighborhood with rolling lawns and good schools. After winning a bidding war, they took out a $300,000 mortgage that required interest-only payments for the first five years. But in 24 months their mortgage will convert to a fully amortized rate, and their payments will rise substantially. They’re worried that they may not be able to make the payment after the adjustment. Paul and Lisa are starting to think they made a mistake with their mortgage.
Many homeowners who took on large mortgages with low initial payments may share Paul and Lisa’s worry that they made the wrong choice. The situation is a cause for concern, but not panic. Here’s how to prepare for the day of reckoning:
1. Consider refinancing.
If you have a mortgage with a low introductory rate that’s about to reset at a higher rate, and you’re concerned about whether you can afford the new higher monthly payments, you may want to think about refinancing. You may also be considering refinancing if you took out a balloon mortgage, which doesn’t have fully amortized payments and will leave you faced with a lump sum payment.
If you regret choosing an adjustable rate mortgage (ARM) because you find the adjustments stressful, you may want to consider refinancing to a fixed-rate loan if you plan to remain in your home for several years or more. If you plan to move in a couple of years, you might be able to get a competitive rate on a hybrid ARM with a low initial rate for a fixed-rate period. Use the LendingTree Refinancing Calculator to see if you can save by refinancing now, even before your current loan resets.
2. Prepare for the inevitable.
If you know that your mortgage payments will rise sharply in a year or two, start preparing now. You may find that living more frugally is not as difficult as it seems. Let’s say that you expect your payments to increase by $300 a month a year from now. Can you reduce your spending by $75 a week by cutting back on restaurant meals or expensive hobbies?
A good way to save is by setting up automated transfers from your checking account to a high-yield savings account. Start at $25 or $30 a week and gradually increase your savings every few months. Chances are that in a year you’ll have adjusted to your new habits. And you’ll have saved over a thousand dollars to boot.
3. Don’t waste time on regrets.
Any time interest rates go up, people who chose adjustable rate mortgages second-guess their decision. Of course, when rates go down, it’s the fixed-rate mortgage holders who wring their hands. Since no one can predict the market, it makes little sense to beat yourself up for the “wrong” loan.
Remember, too, that when you do the math, you may not be as badly off as you think. For example, if you have been carrying an interest-only mortgage for the last three or four years and feel compelled to refinance, you may still end up paying less overall than you would have if you’d started out with a more expensive fixed-rate loan in the first place.
Note: If you find yourself in the unfortunate position of having your mortgage reset with a much higher monthly payment than you can afford, talk to your lender right away. While refinancing is not always possible, particularly there are various alternatives that can help prevent the loss of your home through foreclosure. For more information, read: Alternatives to foreclosure.
Published on November 13, 2007