Mortgage Q&A: Adjust personal spending

By | Friday, September 19, 2008

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Q. We have a 5/1 interest-only adjustable-rate mortgage at 5.50 percent with a balance of $600,000. The rate will begin to adjust annually in two years. We also have a home equity line of credit with a $50,000 balance with a current rate of 4.50 percent.

Although we are able to make our current monthly payments, I am worried we will not be able to afford the new payments when our ARM adjusts. My husband and I have stable jobs with a combined salary of $200,000. We don't have any other debt except a credit card balance of about $12,000.

I checked into refinancing with my current lender, who told me they can't help because our property value has declined to less than $600,000. We have very little cash and cannot pay down the loans. Where can we refinance to keep our payments from increasing?

A. I seem to be receiving a lot of e-mails that unfortunately require unpleasant responses. First, let me answer your question and then allow me to explain and give you my thoughts.

I do not know of any mortgage product available today that would keep your payment at the current level and eliminate future adjustments. Here's why:

First, you have $650,000 in mortgage debt secured to a property worth less than $600,000. Even before the credit crisis, finding lenders that would lend money in excess of the property's value was difficult. If you were able to find one, you would pay a significantly higher interest rate.

Second, the current interest rates of 5.50 and 4.50 percent are already well below market. Fixed rates for loan balances in excess of $417,000 can range anywhere from 6.50 percent to 8 percent, depending on property location, value and credit score.

Third, your loans already carry an interest-only feature. This means you have the option of making monthly payments that cover only the interest charged. There is no principal curtailment.

These reasons explain why your existing loans allow for the lowest payment plans to service $650,000 in mortgage debt. Based on the information you provide, I calculate that your monthly interest payments are $2,750 and $188 on your first mortgage and home equity line, respectively. Let's add $500 for real estate taxes and insurance and your total house payment becomes $3,438.

Assuming the worst-case scenario, your first trust could jump to 7.50 percent and require that it be repaid over the remaining 25 years. This would increase the payment to $4,435 - an increase of $1,650. Although interest rates are difficult to predict, I would guess that the worst-case scenario is unlikely.

Unfortunately, you are not alone in watching your property value decline during the last couple of years. Cycles happen, however, and the next cycle will be in your favor.

I do have some advice. Your situation is not unlike many others that come across my desk, except for the fact that you should be able to afford not just your existing payments, but also an increase. With an annual income of $200,000, I estimate your total house payment, including taxes and insurance, to be only about 20 percent of your gross monthly income. The most conservative lenders consider a house payment up to 33 percent of monthly income to be perfectly reasonable. While $12,000 in credit card debt is not a good thing, the additional monthly payment is probably only about $300. Your situation suggests to me that your consumer spending needs to be curtailed.

A combined annual salary of $200,000 is equal to $16,667 monthly. Let's take out 40 percent to adjust for taxes, health insurance and retirement contributions. This would give you take-home pay of $10,000 a month. After making your mortgage payment of $3,438 and a credit card payment of $300, you still have $6,262 left. Where's the money going?

My advice is to sit down with your husband, take a look at your bills, ascertain where the money is being spent and make some choices on where to cut back.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail at henrysavage@pmcmortgage.com.

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