Q: Four years ago, I purchased a house for $125,000. I paid $100,000 in cash. The seller holds a $25,000 mortgage at 10.5 percent due in five years. The five years will be up in August 1985. What are your suggestions to refinance the house?
A: Once again, as we near the end of a year, it is time to gaze into the crystal ball. And, once again, that crystal ball is quite cloudy.
Nineteen eighty-five may be the year that Congress passes a massive tax reform package, and no one can predict today what such an action will do for the future of real estate. Thus, since your five-year mortgage comes due in August 1985, this may be a good time to start thinking about refinancing.
There are many options to consider. First, you might want to find out from the seller whether they would be interested in extending your $25,000 mortgage for another few years. Even if the seller would want to raise the interest rate to 12 percent, for example, since you will not have to pay points and other lending charges, the additional interest rate would not be terribly significant.
Second, you might want to consider obtaining a long-term mortgage on your house in an amount sufficiently high enough to give you some cash out of the transaction. Assuming, for the sake of this column, that your house is now worth $150,000, you could borrow as much as $120,000. These funds would be used to pay off the $25,000 which you currently owe, and after you pay points, closing costs and other lender charges, you would probably have about $90,000 to use as you see fit. This money is your equity in the house, and is totally tax free. As this column has suggested on many occasions, it is not a good idea to keep all that "dead equity" sitting in your house.
Obviously, if you cannot afford to qualify for a $120,000 loan, this approach may not make sense to you. Additionally, it certainly does not pay to borrow $120,000 at 13 percent and put the bulk of that money into a savings account which may only pay you 10 percent. You have to have some investment goals for using the refinanced money -- such as the purchase of additional real estate, putting money into a pension plan or doing some renovation in your house.
If you decide to obtain a new mortgage, you will then be faced with a wide variety of choices. You can take a fixed 30-year loan, and I suspect that this type of transaction will carry the highest possible interest rate. You could also obtain an adjustable rate mortgage which adjusts every year or every three years, and such a transaction (called an ARM) will carry a lower interest rate, at least for the first year.
There are also loan transactions which fall between the one-year adjustable and the fixed 30-year mortgage. You may want to consider a 15-year fixed mortgage, but this, of course, depends on your own financial circumstances and your age.
In most instances, I do not recommend the 15-year mortgage, since you are paying more toward principal and getting less tax deductions. I have reason to believe that the Congress will not take away the right of homeowners to deduct their interest costs -- regardless of the tax reforms which may pass next year.
I suggest that you contact a number of lenders in your area, and find out what they have to offer. You should also discuss the entire situation with your seller, since they may be willing to negotiate an extension on your current loan.