Mortgage/financial question

[leslie826]

We have a mortgage that had a 5 yr ARM and is interest-only for 10 years. Our ARM is up and our mortgage payment has gone down by half! To this point we have only been paying the interest, no extra toward principle. I am nervous about the future of our rate adjusting, but we cannot refinance because are house is not worth now anything near what we paid for it. Here's my question: Do we take this extra $800 a month that we have now and put it toward principle? Or do we put it in an IRA? ( DH is self-employed and we have no retirement. All we have is 3 months salary in a savings acct.) Thanks for any advice!

 

[flateacher]

You could divide the $$ up. Instead of all in one spot. A little to the mortgage principle, a little to savings account, and a little to an IRA. It would be about $250 each spot. Not bad for each! In a few months you will have savings increased and your IRA increased!

Good luck! It is great the payments went down! Usually they go up! Refinancing is a joke right now anyway - not sure of anyone they are approving!

 

[Darcy03231]

We have a mortgage that had a 5 yr ARM and is interest-only for 10 years. Our ARM is up and our mortgage payment has gone down by half! To this point we have only been paying the interest, no extra toward principle. I am nervous about the future of our rate adjusting, but we cannot refinance because are house is not worth now anything near what we paid for it. Here's my question: Do we take this extra $800 a month that we have now and put it toward principle? Or do we put it in an IRA? ( DH is self-employed and we have no retirement. All we have is 3 months salary in a savings acct.) Thanks for any advice!

So, in 5 years you've paid nothing down on the principal of your loan and if you continue paying the interest only for the next 5 years you still won't have paid anything toward your principle.

If your plan is to stay in the home and eventually own it outright, I would put the $800/mo toward the principal of the loan. If you do that for the next 5 years you'll have reduced your loan amount by about $50k. At that point you may be able to re-finance into a more conventional loan.

If you don't think you're going to stay there and my sell and move, I would figure how much you need to put toward it each month to get to the break even point.

 

[robsmom]

I agree with Darcy. I think that you need to get some equity going in the house. If you job has any insecurity, you might start with increasing your emergency fund to 6 months. After that, I would throw the extra towards the house. What happens at the end of the 10 yrs (5 yrs from now). You have to start paying principal, correct. Will the rate adjust again? How much will your payment go up at that point. Are you 100% sure you will be able to afford it. If there is any chance that you might need to sell, you want to build up the equity.

 

[silmarg]

I agree w Darcy.

In year 10, what will likely happen is you will have to pay interest and principal. And your monthly payment will be way more expensive. So pay it down now while you have the spare cash.

Cause in 5 years, you will be in a world of financial hurt.

 

[a1tinkfans]

I agree w Darcy.

In year 10, what will likely happen is you will have to pay interest and principal. And your monthly payment will be way more expensive. So pay it down now while you have the spare cash.

Cause in 5 years, you will be in a world of financial hurt.

Oh Yeah, get some equity in that home or it will be worthless in the long run an you'll be paying LOTS for it each month...if you do NOT think you will be there in the long run, n10+ years, Id re think the strategy tho...

 

[Glenn]

Since you have no real money in the bank I would put the money into savings. If you put it towards your principal & run into problems you cannt use it to cover your expenses. Retirement savings are a good idea but only after you have some emergency funds, & 6 months now days may be too small with the economy seeming to go down again. Since you had seemed to be barely running at a break even point I would also suggest going over your income & expenses to see where you can save more. Even $5 or $10 a week can add up. Good luck.

 

[Deealee]

Since you're already underwater on the house it makes no sense to pay any more than you have to. That's just throwing good money after bad. I would put $300 towards my e-fund and divide the rest between ROTH type accounts for each of you.

This gives you the option of a stategic default should the value continue to drop or you can raid your ROThs for contributions when you I/O mortgage is due.

 

[MrsPete]

We have a mortgage that had a 5 yr ARM and is interest-only for 10 years. Our ARM is up and our mortgage payment has gone down by half! To this point we have only been paying the interest, no extra toward principle. I am nervous about the future of our rate adjusting, but we cannot refinance because are house is not worth now anything near what we paid for it. Here's my question: Do we take this extra $800 a month that we have now and put it toward principle? Or do we put it in an IRA? ( DH is self-employed and we have no retirement. All we have is 3 months salary in a savings acct.) Thanks for any advice!

This is bad. You've been paying for five years, and you own NONE of your house; you might just as well have been renting. This loan was not in your best interest.

Since you now have $800 that you're not used to having, you should plan well and use it well. I'd suggest splitting it three ways: One portion towards house principle, one portion towards retirement savings, one portion towards short-term/emergency savings. These are ALL essential for financial stablity, and you shouldn't sacrafice any of them for the others.

Also, it'd be smart to see where you can tighten your belt, spend less in whatever area it's possible, and see if you can't put MORE than that $800 towards these three essentials.

 

[surfgirl]

This is bad. You've been paying for five years, and you own NONE of your house; you might just as well have been renting. This loan was not in your best interest.

Since you now have $800 that you're not used to having, you should plan well and use it well. I'd suggest splitting it three ways: One portion towards house principle, one portion towards retirement savings, one portion towards short-term/emergency savings. These are ALL essential for financial stablity, and you shouldn't sacrafice any of them for the others.

Also, it'd be smart to see where you can tighten your belt, spend less in whatever area it's possible, and see if you can't put MORE than that $800 towards these three essentials.

Lots of assumptions here. We don't know what the original downpayment on their house was. Maybe they put down 50% of the purchase price and did the rest on an interest only loan.

There are times for interest only loans -- We chose interest only because with only one income, it reduced our monthly liability in the chance that the one income went away for a while. However, we do make principal payments on top of the interest only to build more equity in our house (and we put down a significant portion of the purchase price).

I agree that you need to split three ways ... in a few months. First, you need to build a better emergency fund. I would stick with the 6 months of living expenses above that are quoted. Once you've funded that, then I would look at buying down mortgage, and funding IRA.

However, there are many variables here:
1) is the income in an at-risk industry or seasonal profession or commission based ? If so, you may want MORE emergency fund.

2) do you have any equity in your house ? When you bought it, did you put anything towards the purchase price or are you 100% mortgaged ? Also, what was the timing... ie. how much has your value gone down ? Are you paying PMI ? If so, try and get rid of the PMI - it only protects the mortgage company, not you.

3) I don't remember, my brain is tired.


good luck.


oh yeah, to the person above who said that no one is refinancing ? We are doing exactly that. We are lucky to have good credit and we had a nice bonus check from work, so we are putting more equity into our house, refinancing the rest, and dropping our interest rate to 3.75%. We are saving a ton each month (although some of that 'savings' is false since it is our equity reducing the payment required). We plan to keep paying at the old monthly rate, thereby increasing the principal payments we were making.

 

[dzorn]

We have a mortgage that had a 5 yr ARM and is interest-only for 10 years. Our ARM is up and our mortgage payment has gone down by half! To this point we have only been paying the interest, no extra toward principle. I am nervous about the future of our rate adjusting, but we cannot refinance because are house is not worth now anything near what we paid for it. Here's my question: Do we take this extra $800 a month that we have now and put it toward principle? Or do we put it in an IRA? ( DH is self-employed and we have no retirement. All we have is 3 months salary in a savings acct.) Thanks for any advice!

Why in the world have you just been paying interest only Unless you planed on defaulting from the beginning that was a unwise move.

Denise in MI

 

[timmac]

It's true what a few PPs have alluded to, that this loan probably wasn't a great move, but what's done is done, and now the question is how best to deal with it.

One question I'd have, is what is your interest rate on the mortgage right now, and what will it be when it's time to start paying P+I? If both are relatively low, I'd look to use that extra $800 into some easily-liquid, not-too-risky investments, and take advantage of a better return that way. Over the next five years, whatever you're able to put away in that manner is going to help you... whether as emergency money, or possibly using some of it to offset your higher mortgage payments when the time comes. Money that you throw towards the principal now is non-liquid and can't do anything for you.

Really, though, to come up with the best solution, will be a combination of what your goals are, and the exact numbers in your situation. Knowing how much you owe in principal on the house, and how much it's theoretically worth, you can then start playing what-if with the numbers, and really have some hard data to back your decision.

 

[RitaE]

Lots of assumptions here. We don't know what the original downpayment on their house was. Maybe they put down 50% of the purchase price and did the rest on an interest only loan.

There are times for interest only loans -- We chose interest only because with only one income, it reduced our monthly liability in the chance that the one income went away for a while. However, we do make principal payments on top of the interest only to build more equity in our house (and we put down a significant portion of the purchase price).

I agree that you need to split three ways ... in a few months. First, you need to build a better emergency fund. I would stick with the 6 months of living expenses above that are quoted. Once you've funded that, then I would look at buying down mortgage, and funding IRA.

However, there are many variables here:
1) is the income in an at-risk industry or seasonal profession or commission based ? If so, you may want MORE emergency fund.

2) do you have any equity in your house ? When you bought it, did you put anything towards the purchase price or are you 100% mortgaged ? Also, what was the timing... ie. how much has your value gone down ? Are you paying PMI ? If so, try and get rid of the PMI - it only protects the mortgage company, not you.

3) I don't remember, my brain is tired.


good luck.


oh yeah, to the person above who said that no one is refinancing ? We are doing exactly that. We are lucky to have good credit and we had a nice bonus check from work, so we are putting more equity into our house, refinancing the rest, and dropping our interest rate to 3.75%. We are saving a ton each month (although some of that 'savings' is false since it is our equity reducing the payment required). We plan to keep paying at the old monthly rate, thereby increasing the principal payments we were making.

She says in her original post that she can't refinance because the value of their house has dropped so much. I won't say much more about this particular mortgage because the previous posters are right ... what is done is done.

I will say that there is extreme unease in the market right now that interest rates are going to rising significantly which means ARM payments will be going up, significantly. Add to that ... that in 5 years this loan will not only be likely paying higher interest, principal payments are going to kick in.

Basically there are 3 problems going on here.

1. No retirement savings
2. An atrocious home mortgage with no easy escape route
3. Anemic other savings

These issues run far deeper I think than anybody could adequately advise on a message board. My honest suggestion is that you take the first month of "savings" on your mortgage payment and find an adequate financial adviser to try and get you out of the quicksand before it reaches your neck.

 

[clutter]

Interest-only loans are not necessarily bad things. Interestingly enough, when I purchased my home with an interest-only, my realtor mentioned that the only ones she's seen were from homeowners that were economists and accountants. Since I have a ton of equity already and will only be in the home for a max of 6-8 years, it made sense for me. It freed up funds to save/invest for other more important things. (My ARM is locked for 10 years, though.)

As for the OP, she doesn't say she's underwater, just that the home isn't worth what they paid for it. In her case, I'd set up a special separate savings/investment account. By setting aside almost $50,000 over the next 5 years, she will have a lot of options over the next few years. If a re-fi opportunity opens up, she could use it to pay down equity if needed. Or if they decide to sell and are underwater, that will help recover. If the market improves (and NoVa is a good place to see that happen), they can keep it as a buffer for the future.

 

[crisi]

Interest-only loans are not necessarily bad things. Interestingly enough, when I purchased my home with an interest-only, my realtor mentioned that the only ones she's seen were from homeowners that were economists and accountants. Since I have a ton of equity already and will only be in the home for a max of 6-8 years, it made sense for me. It freed up funds to save/invest for other more important things. (My ARM is locked for 10 years, though.)

I wouldn't believe your Realtor.

 

[bellarella]

Why in the world have you just been paying interest only Unless you planed on defaulting from the beginning that was a unwise move.

Denise in MI

Blanket statements are generally and unwise move.

We did an I/O ARM with our last house. It was a brilliant move for us. Our interest rate was very low. We were able to save more in those years than we would have paid down in principal with a conventional mortgage. Our interest rate was locked for the period that we expected to own the home and was capped at a rate we could live with if we ended up staying longer.

Now buying the house was stupid, but my crystal ball was on the fritz back then.

For the OP: you need to look at your liquidity risks in figuring out what the best plan for the money is.

It seems like this was a major downward adjustment in your rate. Were you able to pay the old rate comfortably? Was the old rate at the cap or could it go even higher than that.

The risk of interest rate hikes is substantial, but the timing is pretty much unknown. If you are concerned about your ability to pay your mortgage in the future if rates spike, I might go very conservative and put the extra money in a savings vehicle. While you would probably get the best ROI if you paid down principal, if you have liquidity concerns, I think it would be better to protect your ability to pay your mortgage (and thus keep your house) than to maximize your returns. Put the money in a CD or treasury bonds or something similar. You can use laddering after a few months to increase your interest rate (e.g. buying a year long CD every 3 mos so that you have access to money every 3 mos).

Once you have enough money to be able to handle a spike in your mortgage payment, then you can look at balancing retirement and principal payments. But since your mortgage is subject to interest rate volatility, I'd make sure you are protected against that risk before you do anything else.

 

[RitaE]

I wouldn't believe your Realtor.

No really. All of us accountants sit around in our conference rooms nightly speaking of our love for creative real estate financing.

Interest only real estate loans used to be the love child of the house flippers - who were generally planning on holding onto the property for less than a quarter of a year and didn't have a speck of desire to pay down the principal before a sale.

As we have seen, they are deadly in times of rising interest rates and declining property values.

 

[MrsPete]

Lots of assumptions here. We don't know what the original downpayment on their house was. Maybe they put down 50% of the purchase price and did the rest on an interest only loan.

Possible, but from the other details in the post, I think it's not likely. I suspect a fast-talking realtor suggested this creative loan that'd get her into the home, and at that point the OP was inexperienced and thought it must be a good idea.

Interest-only loans are not necessarily bad things. Interestingly enough, when I purchased my home with an interest-only, my realtor mentioned that the only ones she's seen were from homeowners that were economists and accountants. Since I have a ton of equity already and will only be in the home for a max of 6-8 years, it made sense for me. It freed up funds to save/invest for other more important things. (My ARM is locked for 10 years, though.)

Interest only loans can be a good thing in very limited circumstances: For example, if you were flipping a house and expected to own it less than a year, an interest-only loan would make sense. For your primary residence, a house that you intend to "pay off" eventually -- nah.

Incidentally, I wouldn't count on people in math-based professions being good with their own finances. My father was a CPA -- tops in his field -- and his lack of money-management was the biggest thing that led to my parents break-up. My husband, the engineer, leaves the majority of the finances to me; he's brilliant at everything math-related, but I'm better with the dollars and cents.

 

[punkin]

DH was looking to refi our house again given the ridiculously low interest rates currently out there (this was a bit of a joke since we just refied 2 months ago) and I suggested we do an I/O in jest...didn't go over too well.

OP, based on everything, it seems you really can't afford the house you are in. If it was me, I'd get rid of the albatross around your neck and purchase something I could afford.

 

[Deealee]

As for the OP, she doesn't say she's underwater, just that the home isn't worth what they paid for it. In her case, I'd set up a special separate savings/investment account. By setting aside almost $50,000 over the next 5 years, she will have a lot of options over the next few years. If a re-fi opportunity opens up, she could use it to pay down equity if needed. Or if they decide to sell and are underwater, that will help recover. If the market improves (and NoVa is a good place to see that happen), they can keep it as a buffer for the future.

FYI,

I/O mortgage & house worth less than you paid = underwater.