Paying down a second mortgage

draconisskyeJuly 17, 2007

I would like some unbiased opinions on paying down our second mortgage. I understand the tax benefits gained from interst paid, but I HATE looking at that second mortgage and watching the balance go down soooo sloowly, when I know we could pay off at least a portion of it right now from savings. We can't refinance to a lower rate, because we're still well above the 80/20 mark. At least we got out of the variable HELOC before it killed us.

We would like to have kids in the next couple of years, and I would really like to get rid of that second mortgage before that happens. It just doesn't seem like we gain enough in tax benefits from the second mortgage not to get rid of that monthly payment that could go towards so many other unknown things then. I figure we could pay it off in the next two years by using half our current savings and putting any extra cash towards it, instead of adding to our savings or retirement accounts. When it's gone, the same monthly payment would be set up to increase our regular savings and retirement savings accounts. (We're both in our mid-20's, by the way)

I think my emotions get in the way when I look at the amount in savings vs. amount owed on mortgage, and I just can't get beyond wanting to see that second mortgage gone. Anyone have any sensible advice to give?


Approx. 60k per year household income (gross)

110k first mortgage @ 6.00% fixed (25 years remaining)

17k second mortgage @ 7.85% fixed (9 years remaining)

11k savings in a money market account paying 4.26% currently

save approx. 10% of income in 401k/Roth (none maxed)

no car loans or CC debt

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A lot of people on this board will tell you to pay off that second mortgage ASAP, but my opinion (FWIW) is that it's better to (a) put as much as you can into your retirement account and (b) build up your liquid cash. If, after you've done those things, you can easily pay it off in one lump sum while still retaining an emergency fund that can cover 6 months of expenses, that would be worthwhile. Also, your payments for the second mortgage are probably pretty small and you're not paying that much interest. So as much as it bothers you, it's not worth it to throw so much of your savings at it, especially if that's your only easily accessible cash.

Just 2 cents from someone who's been there, done that ...

What might make it a little easier psychologically is if you set up automatic payments for both first and second mortgages. That way you don't have to think about it every time you write the checks because you're not writing checks.

    Bookmark   July 17, 2007 at 3:08PM
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All the tax benefit does is make it a bit less painful. That interest is money down the drain. If it were me, I'd pay it off ASAP. I'd take half of that $11,000K and put it on the principle, then I'd double up on the payments even if I had to take a second job to do it.

Make it a priority, one way or another - you'll be glad you did.

    Bookmark   July 17, 2007 at 4:07PM
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Another voice that says lose the second mortgage. You've just said it makes you uncomfortable, paying it off will only increase your equity. I would "round up" the monthly payment to the next even hundred, earmarking the "extra" to go to principle. I would also make a "13th." payment and direct the entirety of that to principle. You'll retire the second mortgage in a few years that way. It's a relatively painless way to do it, too.

We've recently started a garage. We've plunked down a not inconsequential sum to get the ball rolling. We've taken out a 15 yr., fixed rate Home Equity Loan, and plan to whittle it down just the same way I outlined above. It's how we paid for our home, too. Being debt-free is really nice; but I'm learning that being easily able to control and MANAGE your assumed debt is pretty nice, too.

You need to be "comfortable" with your debt load. Work toward that and you'll feel more confident.

    Bookmark   July 17, 2007 at 4:35PM
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Harriet literally is "right on the money" on this one, IMHO.

I figure we could pay it off in the next two years by using half our current savings and putting any extra cash towards it, instead of adding to our savings or retirement accounts.

You don't say what your source of income is, but unless it's guaranteed, you should have at least three months of living expenses available to you readily -- longer if you have unusual expenses or a job which would be hard to replace. Leaving yourself $5,000-6,000 for such expenses would be kind of tight in most of the U.S.

In addition, contributions to retirement plans made very early take advantage of compounding the likes of which you will not see later in your lives -- especially if you go without contributions for a couple of years to pay off the mortgage and then have a kid or two which will soak up some income for more years.

Much as you're not crazy about holding that second, I would not pay it off right now -- what you'll save in interest you'll give up in compounding interest in your retirement funds and in peace of mind knowing that you're slicing your margin rather thin.

Here is a link that might be useful: Illustration of the benefit of compounding savings

    Bookmark   July 17, 2007 at 11:46PM
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My opinion is that you should do what it is that gives you peace of mind. If you plan on staying home with young children, it makes (yes, even financial) sense to pay as much of your bills down or off as you can before you the birth. Yes, you pay a few more tax dollars in a few years on the house, but then again, you may have a little "tax write-off" to balance it out. I would not neglect the savings though. You never know what you will feel like after having children, and you may want to stay home for a few extra months with a new baby. Of course, you may not, but at least then you would have options.

For what it's worth, my opinion is that your peace of mind is worth more than a few dollars, and if that is what it will take to give you peace of mind, pay it off as soon as you can. =0) You win and lose either way, either paying down the debt of your home, thereby building equity faster (and paying more in taxes)..... or waiting and paying it off on the bank's schedule (and paying more interest.) 7.85% is not the best rate out there, but it's not the worst either.

I'd find another way to get the "extra" cash though. A change jar on the dresser, a romantic dinner at home instead of out, something. Depleting your savings would not be a route I'd recommend, unless you could pay it off, all one lump sum.... and even then I'd have reservations.

Good luck!

    Bookmark   July 18, 2007 at 8:20PM
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I think you should pay down the 2nd mortgage as soon as you can. Your money market account makes 4.26%, you're paying nearly 8% on your 2nd, so in essence, you are losing money not only paying the interest, but your savings rates do not even come close to the rate you are paying on your second mortgage.

I wouldn't use all your savings to pay down the 2nd, but I would make a concerted effort to allocate as much of your extra money to it while still contributing to your savings. Once you have kids, you will not have your second income either temporarily or permanently if you become a SAHM.

If you are that uncomfortable with your level of debt, then you have to do what makes you feel best. You are still young and while the benefits of compounding interest are notable, you're spending far more than that on interest on your mortgages and probably not getting much tax benefit from it. Your ROTHs will still gain (hopefully) if you reduce your contributions to concentrate on paying down that second mortgage.

From the stats you gave, I can see the 2nd mortgage costing you more money than you're gaining by your money market account and Roth IRAs.

    Bookmark   July 18, 2007 at 9:47PM
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Thank you for all of the thoughtful, informative suggestions. It is always helpful to see how others view and would tackle a problem, when trying to make your own decision.

I see the merit in both sides, keeping a large emergency cushion available and paying the mortgage down as we can, or trying our hardest to get rid of that interest drain quickly and then turn to rebuilding our emergency cushion.

We do have automatic payments set up on both of the mortgages, and we pay an extra $150/month on the second mortgage right now.

My hubby and I are of opposite opinions on this, he would prefer to keep the savings account, whereas I would prefer to kill off the mortgage.

I think the best choice for now, is to put as much extra as we can find into a separate savings account, to keep track of it, and see how quickly it builds. In another six months or a year, we can reevaluate our savings and see if we've reached a point we can comfortably pay off the remainder.

We both work full time, and in very different fields, so I'm not that worried about both of us losing our jobs at the same time, even if something happened to one of us. And I just wish I could stay home after the kids, unfortunately for me I make 2/3 of our income. He'd be happier as a SAHD than I would as a SAHM anyway.

    Bookmark   July 19, 2007 at 12:15PM
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You speak of your incomes being fairly secure.

But your $11,000. is much less than a quarter of your annual income ... however in emergency use it would come without tax liability.

Would it be possible to set up a line of credit without initial set-up fee, or a regular fee for non-use, or at too high a rate of interet, which you could draw on, in case of emergency?

If so, I would feel somewhat more comfortable with you using part of your current saving to pay down your second, if you could draw on a line of credit in case of emergency.

It appears that you have used up most of the equity position in your house, so it might be difficult to use it to undergird the line of credit, as well.

Has there been a decline in value of housing in your area?

Some feel that house values have been somewhat too high in many areas, but in quite a few areas there's been some recent erosion of value, as well.

Lacking some other source of emergency money (e.g. parents, rich relatives), I'd hate to see that value of your home drop enough that it barely covered the mortgage amounts, meaning that the bank would almost certainly call your loan using the line of credit.

Are you working with a bank?

Is there a credit union in your area in which you are eligible for membership?

Sometimes they are more inclined to stretch rules for dependable-appearing folks than banks may be.

Just some ideas that may be of value.

I should add that I, differently from most financial advisors in this country, am much less enthused about our tax-deferred retirement accounts, as I feel that one loses a couple of other valuable investing benefits when using them.

So possibly my bias relating to our situation enters the balance of my thinking regarding the wisdom of your paying into a retirement account currently.

Good wishes to both of you.

Learning how money works is an interesting hobby ... and it pays well.

ole joyful

    Bookmark   July 19, 2007 at 8:09PM
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Joyful makes a very good point for the merit of paying off the 2nd. House values are declining. Many people who did 100% financing the way you did are in a negative equity situation solely because the value of their home has dropped.

What if you go to sell in two years when you have a couple kids and the house is no longer big enough? Will you be in a position where you will have to take money to closing because you owe more on the home than it's worth?

You could very well be in that situation if house prices continue to drop. That 20% 2nd mortgage could be a real problem down the road.

Even if you don't plan to sell, you never want to be in a negative equity position. Paying off the 2nd will help alleviate that.

    Bookmark   July 20, 2007 at 5:08AM
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We actually do have a 19k HELOC set up for emergency use only with a 8.25% interest rate. Haven't used it yet and never intend to.

We bought the house 4 years ago for 156k and currently owe 137k. Housing values in our area have gone up, and seem to be holding steady around us right now. We have fixed quite a few issues the house came with, including a full tear-off roof replacement and adding a new full bath, so I don't think we would have any trouble selling for more than we bought.

And this silly house is so oversized for us right now that even when we had four adults living here full-time it wasn't too crowded. It's more a matter of wanting to move to the country as soon as we can afford it, rather than needing to move up in house size or school district.

Your comments have reinforced my opinion that reducing our mortgage load ASAP really is in our best interests.

    Bookmark   July 20, 2007 at 11:35AM
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Personally, I would pay off the second because you said:

17k second mortgage @ 7.85% fixed (9 years remaining)
11k savings in a money market account paying 4.26% currently

You are paying more in interest than you are earning on the savings. And Money Markets can change.

Call the bank you have the second with and ask what the pay off amount is. The 17k is based on the interest total with 9 years remaining. Odds are you will still have a chunk of change left out of the 11K. Put the left over and what you were paying on the second back into savings as if it was a bill.

If you really want to save the money.. as of today, according to (my bank so the only place I looked), you could put $10,000 of that 11k into a 7 or 9 month CD and it would earn 5.15%. Better than the Money Market, a guaranteed, federally insured return, AND the money will be liquid again in 7 or 9 months. Maybe then it will be better to put it back in the Money Market, or maybe not.

    Bookmark   July 20, 2007 at 2:29PM
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draconisskye - Your comments have reinforced my opinion that reducing our mortgage load ASAP really is in our best interests.

Given your situation, I think you are very right.

110k first mortgage @ 6.00% fixed (25 years remaining)
17k second mortgage @ 7.85% fixed (9 years remaining)
...We bought the house 4 years ago for 156k and currently owe 137k.

You know something? You may be able to get out of that 2nd mortgage quicker than you think. If you paid $156K for the house and values in your area have gone up, then you could very well be beyond the ratio for requiring PMI, which is why you took out the 80/20 (I presume).

It may be in your best interest to get the house appraised to see how much it has grown. Right now with both your mortgages, you are at 13% of the original value. With a higher appraisal, it could very well take you over 20% and then allow you to refi into one single mortgage. You could also pay down the amount that will take you down to 20% without tapping too much into your savings.

You would still owe $137K, but it would be in one mortgage, lower interest rate and smaller overall payments, thus saving thousands and thousands in interest.

Crunching the numbers, all you would need is an appraisal of $165K (approx). Alternatively, you could pay down your 2nd by $7K to take your total amount owing to 130K and with the amount you paid ($156K), you would be under 80% - enough to qualify for no PMI and a single mortgage refinance. If the value has increased, you would need less than $7K to do it.

However, there are closing costs associated with that, but there are lenders offering no closing costs right now.

Without paying it off entirely, you do have some alternatives to get out from under this. Your situation is one that is a very good example of why taking an 80/20 to avoid PMI can bite you in the bum in the future. It costs so much more in interest than it's really worth. People don't know that they can pay the PMI outright in full at closing. That saves thousands in interest over the life of the loan.

So, first step - get an appraisal. Then crunch the numbers. By law, the lender must remove PMI when you owe less than 80% of the VALUE of the home, not what you paid.

And like someone mentioned upthread, your 2nd may not be as high as 17K, so you could be close to the needed ratio already without even knowing it, so get the payoff numbers too.


    Bookmark   July 21, 2007 at 1:06AM
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