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Author: tigemac Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 127220  
Subject: Need some interest-only mortgage advice please Date: 6/13/2004 2:58 PM
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Hello Everyone,

My wife and I are set to re-finance our home. We've lived here 6 years and here is the breakdown of what we currently owe versus what our home just appraised at:

Owe: $189k
Appraisal Value: $243k
Total Equity: approx. $54k

We have been thinking about moving at some point and converting this home to a rental. We have investigated various mortgage plans that would give us some decent cash flow on this property.

We have decided to live here a bit longer and save as much $$$ as possible in anticipation of this move. We are considering some creative financing as it would allow us to save even more money each month in preparation to move to a bigger home. It would also give us the added advantage of being in a position to easily rent the home as the creative financing (and the associated lower monthly payment) would allow us to do this.

We are interested though in the long-term financial repurcussions of what we are considering and we would ultimately like two questions answered from this post here on the Motley Fool:

1. Is the financing we are considering Foolish or foolish?

2. Where would be a good starting place to contact someone to give us INDEPENDENT financial advice on these types of things? We are working with a mortgage broker whom we like on this deal. However, we do want a "2nd opinion" so to speak on what we are considering. Someone with no ties to profit in our refinancing deal. In other words, a true objective opinion. Who would we look for in the Yellow Pages for something like this? Someone who wouldn't try to sell us another loan!

Here is the financing we are considering as best I can explain it:

It's called a "One Month Option, Adjustable Rate Mortgage". Here is how it works. Each month we receive a loan statement that lets us choose the payment amount that best suits our current financial needs. We can pay the minimum amount to free up funds for other uses, or make a larger payment to build up equity. The monthly payment options are:

* Minimum Payment Due - Saves cash when necessary. Payment changes annually and is calcluated using the inital interest rate for first 12 months. Recalculated annually thereafter and based on outstanding principal balance, remaining loan term, and prevailing interest rate. 7.5% payment change cap limits how much this option payment can increase or decrease each year.

* Interest Only Payment - Pay this when minimum due is not sufficient to pay the monthly interest due. Avoids deferred interest. Paying this equals no change in principal balance for that month. (NOTE: This option will only be offered if the interest only payment is less than the minimum payment due that month).

* 30-year Full Principal and Interest Payment - Full amortized payment based on 30-year loan. Calculated each month based on the prior month's interest rate, loan balance, and remaining loan term. Pays all of the interest due and reduces principal to pay off loan on schedule. (NOTE: This option will not be offered if the full principal and interest payment is less than the minimum payment due for that month).

* 15-year Full Principal and Interest Payment - For faster equity build-up, quicker payoff and substantial interest savings. Calculated to amortize loan based on 15 year term. (NOTE: Offered only on the 30- or 40-year term and will cease to be an option when the loan has been paid down to its 16th year).


RATES:
=========
- Interest rate for this plan is fixed for an initial 1-month period. Thereafter the interest rate can change monthly based on a rolling yearly index.

- Current rates are:

Rolling Index: 1.229
Margin: 2.50

Current Fully Indexed Rate = 3.729% (Rolling Index + Margin)

Rolling index history over last 10 years:
Highest: 6.248% (August 1995)
Lowest: 1.225% (March 2004)

Again, the rolling index is averaged over a 12 month period so as rates climb so will the index (albeit rather slowly since it is averaged). It seems to me based on a non-mathematical analysis that the rolling index average of the last 10 years has been in the 4.5% range. It has been below 3% since March of 2002. Between 1996 and 2001 it fluctuated beween high 4% to low 6%.

PAYMENTS:
==========
Our current monthly mortgage payment (on a 5 year ARM) is $1191/month).
The proposed loan would lower our payment (interest only) to $675/month. That amount does NOT include taxes and insurance. Taxes and insurance under this program as NOT escrowed. We pay them out of pocket ourselves (which with the monthly savings on this payment is not a big deal at all). Taxes on this property are $1600/year and insurance around $700/year.

COSTS:
======
To be sure we are doing the right thing is important to us. This particular loan will cost us about $2100 in closing costs and has a one-year prepay penalty. Thus, we want to make *SURE* we are doing the right thing.

ALTERNATIVES?:
===============
If this loan program is a bad financial idea can someone please recommend some alternatives? What makes the best financial sense for us now and in the future (when we think we may rent this home and buy something larger)?

Again, the goal is to maximize our current cash reserves and save as much $$$ as possible. Getting our payment down even lower than it is now is something we would very much like to accomplish. Is this a reasonable financial objective with this particular mortgage? Or are we robbing ourselves of long-term equity?

Thanks so much for your helpful advice...
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