Mortgages
-- Rate Hike Survival Guide by Cybele Weisser
June 2006
[Continued, page 2]
The Interest-Only Payers
Little Equity, Much Unease
Shortly after they were married,
Aaron and Lacey Blank, now 25 and 27, wanted just what you'd expect:
to buy their first home and start a family. But like many young
couples, the Blanks had trouble scraping together a down payment
for a house in pricey Seattle. By the time they found their three-bedroom,
newly built home 40 minutes from downtown last year, they had
set aside just $16,000. "We weren't planning to buy a place so
soon, but we fell in love with the home and the area," says Lacey,
a family therapist.
Their
stash barely covered 5% of the $330,000 home price, and lining
up the financing proved to be daunting. Though Lacey and Aaron,
who works in public relations, earn a combined income approaching
six figures, their $90,000 in student loans made it hard for them
to qualify for a fixed-rate loan. Their solution amounted to a
financial high-wire act. The Blanks took out a $271,000 interest-only
hybrid ARM with a rate of 6.4% and monthly payment of $1,440 for
five years. To cover the rest, they used a $51,000 variable-rate
home-equity line of credit. By doing so, they avoided paying for
private mortgage insurance (PMI). After taxes, the HELOC's initial
$346 monthly payment was less than PMI would have cost.
A
flush housing market in Seattle, where home prices rose
15% last year, has bought the Blanks some breathing room;
based on recent sales in the neighborhood, Aaron estimates
that their home is worth at least $380,000. But that hasn't
offered the Blanks much peace of mind because they aren't
paying down principal as they'd hoped. "I want to build
some equity, but we haven't really been making much headway,"
says Aaron. The rate on their HELOC has already hit 10.6%,
or another $115 a month. The $1,900 Aaron and Lacey spend
on their home loans every month is still manageable, but
with their first child due any day, they are understandably
nervous. In theory, the Blanks could see their mortgage
rate jump as high as 11.4% in 2009. Add in principal payments
and a 14% rate on their HELOC, and their worst-case scenario
is a monthly nut of $3,445.
>> The Solution
Refi with a fixed-rate loan; pay down the HELOC
The Blanks need to lower their
interest rates, and their robust local market may help them do
that. The couple are paying more on both of their loans than the
best rates available a year ago, says Augusta, Ga. financial planner
Bill Cleveland, probably because of their student-loan debt and
high ratio of debt to home value. Now that price appreciation
has beefed up their equity, and they have a track record of on-time
payments, they should be able to lower their HELOC rate simply
by calling the lender. "I've had clients successfully lower their
rate to just over prime by threatening to take their money elsewhere,"
Cleveland says.
Next up, the Blanks should lock
in the rate on as much debt as they can. Taking out a new, 30-year
fixed for $304,000 (the full 80% of their current home value)
would let them pay off their ARM, shrink their HELOC to $18,000
and start paying down equity. (Many lenders will do a lower-cost
refi to keep your business, so ask.) If they qualify for the best
rates, they'll be paying $2,050 a month for both loans, an amount
they can comfortably swing.
