To Refinance Or Not To Refinance?

It's now almost 5 years since we moved into our current home and in 2 months time, my mortgage rate will re-adjust. We had planned on staying on the property for a maximum of 5 years but with the U.S. economy on it's knees, we have not only decided to stay put but also not to trade-in my missus' 5 year old car which we also bought then.

My current interest rate, which expires after my April payment stands at 3.875% and is tied to the 1 year LIBOR plus 2.25%. At time I was pre-approved, the 1 year LIBOR stood at 1.41% as opposed to 1.9% as of the writing of this post. My rate can not re-adjust by more than 2% and therefore I am looking at the rate resetting to no more than 5.875% which is a much higher rate than what banks are offering for standard mortgages.

At the current LIBOR, which has been steadily falling owing to the current aggressive monetary policy, I expect my mortgage to re-adjust to around 4.25%. Compared to the 5% interest rates that banks are offering for longer term mortgage, I'm at a dilemma as to whether to lock in my rate for the next 5 years or let it re-adjust to the new rate for the next 12 months.

The way my current adjustable rate mortgage works is after the initial 5 year period, it re-adjusts after every 1 year to no more than 8.875%. I've called Wells Fargo and they offered me a choice of another 5 year ARM at 4.75% or a 30 year fixed rate at 5.5% with no closing costs for both options.

While it is possible that the LIBOR may fall further, especially if the government agrees to take over some of the bad loans there is a risk that the opposite may happen. It may be that rates will not fall further and this is the best rate that may come my way for a long time to come. On the other hand, the housing market is dead and banks may have to lower their rates even further to attract new home buyers.

And should I choose to refinance, Wells Fargo may offer me a lower rate than they have quoted if I take out part of my equity and sign up for a bigger loan. But it also gets more interesting. I have a unused home equity line of credit that offers me a 3% interest rate as it is tied to Prime Rate which currently stands at 3.25%.

Which makes me want to take out the money from my home equity line, pay down my mortgage and then refinance my mortgage. That way, I'll have 2 loans. the primary mortgage at around 4.25% and a secondary mortgage at 3%. And in both cases the mortgage interest is tax deductible.

I have the next 30 days to figure out what I will do.