How can we use $15,000 to lower our monthly mortgage payments?

Coins shaped like a house

Q. My husband and I have a 30-year ARM for $255,000 that is now at 8.2% interest and that we took out a year ago to buy a house for $295,000. Now, we've got around $15,000 and want to use it to lower our monthly payments. Should we use it to pay down our mortgage so that we build up 20% equity in our home and then cancel the PMI? Or should we refinance to a fixed rate of about 6.2% knowing that we'll have to pay refinance charges and a penalty for paying off the ARM before two years?

You definitely have a loan you need to get out of but that pre-payment penalty is a killer.

We figure you're paying about $1,900 a month for principal and interest. Refinancing to a 6.2% loan would lower your payments to about $1,450 a month, assuming you used the $15,000 to lower your debt to $240,000.

That should result in enough savings to offset the cost of refinancing in well under a year.

But would you save enough to offset the cost of the loan and the prepayment penalty?

If so, refinance as quickly as you can.

Unfortunately many pre-payment penalties are around $10,000, and if that's the case with your ARM, refinancing before that expires is a money-losing proposition.

We figure that getting rid of your mortgage insurance would save you about $100 a month.

But using the $15,000 to pay down the principal on your existing loan would only raise your equity to about 18% of the purchase price.

Your home would have had to appreciate to about $300,000 over the past year to eek out the 20% equity you need.

Your lender is almost certainly going to require an appraisal (which you would have to pay for) before agreeing to drop the insurance.

We suspect the calculation will be close enough that there could be a lot of back-and-forth before you prevail. If you prevail.

And you'll still want to refinance as quickly as you can avoid the pre-payment penalty because insurance or not, this is a bad loan.

So how about a third alternative: Put the $15,000 into a CD.

You should be able to earn about 5% or $760 over the next year.

That's well over half of what you'll pay in mortgage insurance.

Then have a new, cheaper mortgage all lined up to payoff your ARM the day the pre-payment penalty expires.

Armed with the appraisal you'll have to get for your new loan and the extra $15,700, you'll have a much easier time establishing that you have 20% equity with your new lender.

That isn't a great solution, but there aren't a lot of good options here.

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