Locked in, but not for long
Toni Lapp risks hundreds more in monthly payments come 2009. Should she refinance now? Or stick it out?
 NEW YORK (MONEY Magazine) - Two years ago, when Toni Lapp bought a three-bedroom, 1 1/2 bath house in a neighborhood near downtown Kansas City, the divorced mother of two figured this wasn't the last house she'd own. So to buy the $207,500 home, she took out a $162,000 mortgage with a rate that's fixed at 4.6 percent for five years and adjusts annually after that, giving her a monthly payment of just $833 at first vs. $958 if she'd used a 30-year fixed-rate loan.
"I realized, looking back, that I had never lived anywhere longer than six years, so a five-year ARM seemed like a safe bet," says Lapp, 38, a medical writer. But now, less than two years later, she's wondering if that seemingly safe bet was shortsighted. Today, Lapp is not only thinking of staying longer than five years, she's also considering investing more in her home. With sons Ryan, 13, and Cory, 10, getting older, she feels that her 1,500-square foot house is too small, and she'd like to have a family room and a second full bath. But worries about her upcoming interest-rate adjustment have left her paralyzed. Already, ARM rates are more than a point higher than what she's paying. When Lapp recently checked the fine print on her mortgage, she discovered that her interest rate could jump as much as five percentage points when it adjusts in 2009, to a rate of 9.6 percent and a monthly payment of $1,272 -- a $439 increase. "That was a rude awakening for me," she says. "On top of that, I think about the point I paid for this loan and what a waste that would be if I refinance or sell." The solution: Stand pat, and hope rates are lower in three years
One thing is nearly certain: Whether Lapp gets a new loan now or later (or sits tight and lets her mortgage adjust), she'll have to write a bigger check someday. If she takes out a 30-year fixed mortgage today, her payment will go up by $180 a month. If she does nothing, her monthly payment could increase far more. Lapp needs a new mortgage, but when? The answer comes down to mood as much as mortgage rates. Because Lapp is so nervous about paying a higher rate, Tampa financial planner Elaine Scoggins suggests she lock in a fixed rate soon. "She's a single mom raising two kids, so she needs to consider how much stress she will feel as she marches toward the five-year period and sees rates jumping around," Scoggins says. But if Lapp can stomach a bit of risk, chances are she'll come out ahead by hanging on for a few more years, says Keith Gumbinger, a principal with mortgage data provider HSH Associates. "If she refinances now, she'll lose that nice low rate, and there's no reason to assume that rates will be higher than they are now when she comes up for the adjustment," he says, noting that because mortgage rates have historically moved in five- to seven-year cycles, there's a good chance that in three years they'll be headed back down. Another reason to wait: Lapp isn't sure how long she wants to stay in the home. To cushion the risk, Gumbinger suggests Lapp build up her savings (she recently paid off her car loan, freeing up a few hundred dollars a month). That way she'll have cash on hand to cover more costly monthly payments if rates are higher than they are today when her loan adjusts or she refinances. The last consideration is Lapp's hoped for renovation. She's prepared to borrow another $20,000 to add a room and expand the bath. Even though her home has appreciated modestly since she bought it, she doesn't have enough equity to fund the work by refinancing for more than her current mortgage balance and taking cash out. Given that, a home equity loan (which would cost about $200 a month at today's 8 percent average rate) is her best option, and she would likely recoup much of her investment in an extra room and bath, even in a slower housing market. Finally, Lapp shouldn't sweat the point she paid on her original loan. Notes Los Angeles financial planner Jeffery Harwood: "That's a sunk cost and irrelevant to the decision about whether to refinance today."
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