Dear Benny: My husband and I have two kinds of loans on our house. The first is interest-only with a 6.25 percent interest rate and the loan amount is $286,000. It will be adjusted in five years, which will be sometime this coming spring.
The second loan carries an interest rate of 8.375 percent with a principal balance now of $151,603. We are paying $110 in principal and $1,061 in interest monthly. It has the same five-year adjustable-rate life and started the same time when we bought our house for $440,000.
Both of us have good credit. Is it possible for us to get a fixed 30-year loan with a lower interest rate combining the two loans? If so, when should we do this and what should we do?
By the way, when we bought the house, we did not have money for a down payment, and that’s why we went to a loan broker to help us to get 100 percent financing. — Mary
Dear Mary: Unfortunately, the days of 100 percent financing are just about gone.
Most borrowers who obtained such loans are now underwater; their mortgage loan is greater than the value of their house. In fact, the 100 percent financing was one of the major catalysts of our current mortgage/foreclosure crisis. Borrowers could not refinance because they had no equity in the home and, if they tried to sell, they would have to come up with the difference between the contract sales price and the outstanding loan balance.
Do you have equity in your home? If so, you may be able to refinance. Talk with several lenders, especially about getting an FHA mortgage. Often, such a mortgage carries a decent rate, and in many cases the lender will not require a lot of equity to be in the house.
Unfortunately, interest rates, while still quite low (as of this writing still below 5 percent), are slowing creeping up.
Here’s a suggestion: Talk with the lender who holds your first mortgage. Explain your situation and tell him/her that the monthly payments are too high and you don’t know how long you will be able to continue to pay them. Ask the lender if you can arrange a loan modification, whereby the lender will give you a new first mortgage based on the combined values of your two existing loans but at a rate that is considerably lower than what you are currently paying.
I can’t promise success, but it never hurts to ask.
Dear Benny: Is there any benefit to paying a “lump sum” payment at the beginning of the year for the sum — or greater than the sum — of the mortgage payments for the entire year?
I currently make extra principal payments monthly and plan to change this to make at least my additional principal payment in one lump sum in January. However, I was wondering if there would be any advantage to making the total payments for the year — in addition to the extra principal — in January versus leaving the money in a money market account. This mortgage in question is relatively small, and I currently keep one year’s worth of payments in a money market account for this mortgage. — Dave
Dear Dave: If you are currently getting less than 1 percent interest on your money market account and are more or less financially stable, the answer is a loud yes.
Let me explain by way of numbers. Let’s say your mortgage balance is $100,000,and the interest rate is 5 percent. Let’s further assume that you pay $500 each month toward principal. The monthly interest payment — rounded up for this example — is $416. So the first month you pay $516. Your new balance is now $99,500 ($100,000 less the $500 principal).
Now the 5 percent interest is calculated on that new balance, which is $414.58. (Note: Multiply $99,500 x 5 percent and divide by 12 to get the monthly interest.)
As you can see, the interest goes down very slowly each month.
But let’s say that you send the lender $5,000 in January, making sure that you make it clear on both your check as well as the payment coupon that this is to reduce principal. Now, instead of a balance of $99,500 in February, your loan balance will be $95,000. Interest for that month will be $395.83, clearly considerably lower than if you only make the regular monthly payment.
Yes, it makes sense to reduce your principal by making extra payments. And it is even better if you can afford to make one lump sum payment at the beginning of each year. In effect, instead of getting peanuts on your money market account, in my example you are in effect getting 5 percent.
Benny Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column. Questions for this column can be submitted to firstname.lastname@example.org.