Question: I purchased a home in Southern California with my sister and a good friend about six months ago. We are first-time home buyers and plan on selling the property in two or three years after the property has appreciated considerably in value.

We have a 1st trust mortgage that's fixed for five years at 5.25 percent in the amount of $344,000. We also have a 2nd trust in the amount of $87,000 at 9.75 percent. Our total payment, excluding taxes and insurance, is about $2,800. My roommate's acquaintance is in the mortgage business and suggested that if we refinance to an interest only loan we could cut our payments in half. This is something that I find hard to believe. Is this possible, and if so, is it something that you would recommend? I might add that both of our existing loans carry a two year prepayment penalty in the amount of six months' interest.

Answer: No, I don't think refinancing to an interest-only mortgage would be in your best interest.

Your roommate's acquaintance is correct in that some interest-only adjustable-rate mortgages will cut a mortgage payment in half. A $344,000 loan at 5.25 percent amortized over 30 years will make a principal and interest (P&I) payment of about $1,900 per month. The same loan amount borrowed on an interest-only LIBOR ARM at 3.125 percent would require a payment of only about $900 per month.

This may look great on the surface, but I caution against making such a move for several reasons.

The most obvious obstacle is your prepayment penalty, which is a killer. We're talking penalties of over $9,000 on the first trust and over $4,200 on the second trusts. Believe me, you do not want to incur more than $13,000 in penalties to refi to an interest-only loan. Frankly, I question your original loan officer's judgment if he recommended loans that carry prepayment penalties. You have expressed to me that your plan is to hold the property for two or three years. With such a short holding period, prepayment penalties should have been avoided.

'Nuff said about that. Even if your existing loans carried no penalty for early payoff, I would question the wisdom of refinancing to an interest-only loan. Let's assume for the moment that you are considering a monthly LIBOR interest-only ARM with a current rate of 3.125 percent. This is surely one of my favorite products but it's not for everyone, including you. Here's why.

First, because you purchased your house by taking out a first and second trust, I'm assuming that you put, at most, only five percent down. Taking out two loans in exchange for one loan eliminates private mortgage insurance, or PMI. That's typically a smart move, although 9.75 percent for a second trust is pretty high. You may have been better off by obtaining one loan and paying the PMI. If you refinance both of these loans to a LIBOR ARM, you will be forced to pay PMI, something that could cost somewhere in the range of $400-$500 per month.

To avoid PMI, you'd have to refinance only the first trust. This is questionable as well. Why? Well, your current rate is fixed at 5.25 percent for five years. Is it better to refinance to a monthly ARM with a current rate of 3.125 percent? Even though I believe short term rates will remain low for a while, there's no guarantee that the LIBOR won't start creeping up. The bottom line here is that you'd be trading five years of interest rate security for an ARM with a lower rate that can adjust monthly. Consider this carefully.

The last thing I'd like you to consider is the wisdom of paying interest-only on a highly leveraged property. What I mean by this is simple. You have only five percent equity in the property and are considering a loan that allows payments that doesn't bring down principal balance. Your plan on holding the property for two or three years and then selling, taking a nice profit.

That's fine and dandy, but what if the property doesn't appreciate? What if the market turns and in two years from now you find that your home is worth 10 percent less than what you paid? You would then be "upside down," meaning you would owe more on your home than it would be worth. I'm not saying this will happen, but it's happened before and it's certainly possible. A recent column I wrote on the subject generated a lot of response that basically shared my concerns of an overvalued real estate market.

To sum up, my advice would be to stay put, primarily because of your prepayment penalties. If you can convince your lender to waive them, have an experienced loan officer carefully look at the numbers before deciding to jump into a refinance.