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Should You Pay Your Second Mortgage Early?

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Second mortgages are a lot more common now than they were just a few years ago. There are several reasons for this – many people took out a second mortgage to make home improvements, consolidate their debt, or because they purchased their house with a small down payment and wanted to avoid Private Mortgage Insurance (PMI).

pay second mortgage earlyRegardless of the reason someone has a second mortgage, there is a near universal truth regarding second mortgages – they usually come with much higher interest rates. These higher interest rates can be deceptive because the monthly payments tend to be small, but stretch out for long durations, often as long as your primary mortgage, or up to 30 years.

Should you pay off your second mortgage early?

I recently received a reader question regarding his 2nd mortgage, and whether or not it would be a good idea to pay off mortgage early. A condensed version of his situation is below:

I have a second mortgage which I am considering paying off early. Here is my situation:

  • I recently refinance my first mortgage and am now paying about $1,680/mo (5.25% 30yr fixed). The total amount of the refinanced loan is $245,000.
  • I still have a second mortgage of $28,800 (7.875% 30yr fixed) and I’m paying about $223/mo.
  • I personal savings is about $70K which is only earning 1.9% interest.
  • The second mortgage company is offering a promotion to give me $500 if I payoff my second loan.

Should I take money out of my savings and payoff this second loan?

I figured 7.855% vs 1.9%… I’m better paying off this second loan. But are there tax implications and possible other factors that I have not taken into consideration. What else should I consider??

Thanks for the question. There are several considerations – the interest you are currently paying, how much your savings is earning, what else you may need the money for, taxes, and peace of mind.

Financially, paying off the mortgage is the clear choice

The numbers don’t lie, and financially, paying the mortgage off makes sense by the numbers: not paying 7.855% interest beats earning 1.9% interest every day of the week. In addition, you get a $500 bonus as part of your lender’s promotion. Score!

If you want more proof of how the numbers will work for your situation just visit an online mortgage calculator and run the numbers (or use the numbers you provided). The lifetime cost of the second mortgage is over $80,000! ($223 * 12 * 30 = $80,280). I’m not sure how much of your second mortgage you have already paid, but paying off your mortgage now could save you close to $50,000, most of which is interest.

How much interest are you paying? Try this quick exercise to see how much of your debt payment is actually going straight to interest each month, and how little is actually paying off the principle.

Tax considerations of paying off your mortgage early

You can usually write off mortgage interest as a tax deduction, but honestly, the tax savings on the interest you are paying each month would be negligible compared to the interest savings of paying off your mortgage, plus the $500 bonus. It also doesn’t make much financial sense to continue paying money, just to save money. This is really a non-factor and shouldn’t affect your decision.

What else will you need the money for?

This is a big one. $70,000 is a nice chunk of cash, and it is probably enough to make you feel very comfortable in your financial situation (assuming your mortgage debt is your only debt and you aren’t drawing on that $70k each month to meet expenses). Many people recommend keeping a large cash cushion as an emergency fund, which can be used to help deal with any unexpected expenses that come along.

How big should your emergency fund be? That depends on your lifestyle, job security, risk tolerance, and many other factors. Many “financial experts” recommend 3-6 months of living expenses. If you kill that second mortgage in one fell swoop you will have roughly $40,000 left in your savings. If that still covers your emergency fund and any other major expenses you are expecting, then it might not be a bad idea to consider doing it – from a numbers standpoint.

Peace of mind

All of this brings us to the final consideration – peace of mind. Will you rest easier knowing you no longer have a second mortgage at a higher interest rate? Will the extra $223 in cash flow help with other financial goals? Or does having $70,000 in the bank feel better than paying off your loan?

Is it better to pay off your second mortgage early?

By the numbers, paying it off will net you the best result by far. Other benefits include increasing monthly cash flow which will allow you to replenish your savings or work toward other financial goals, and removing a debt from your life. If you really want to speed things up, pay off your second mortgage and use that extra money toward your primary mortgage each month – you will shave off almost 10 years of mortgage payments – and tens of thousands of dollars in interest.

But personal finance is about much more than just numbers. If you have a need for the funds or feel more comfortable holding on to the cash due to economic, professional, health, or other concerns, then by all means, do what is best for your situation.

Readers – did I miss anything, or do you have other ideas to consider?

Image courtesy of ddpavumba / FreeDigitalPhotos.net


Published or updated April 5, 2013.
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{ 66 comments… read them below or add one }

1 Financial Samurai

Ryan, in your scenario of 7.875% mortgage vs. 1.9% savings, it certainly means one should start paying the 2nd down with the cash reserves.

However, is 7.875% a realistic HELOC percentage? What I did instead two years ago was use my $100,000 HELOC at 3.25% to pay down $100,000 of my principal of my first mortgage rate of 5.25% to arbitrage it out. I wrote about it in “Going Broke To Win Big HELOC Edition”.

I’d be surprised if HELOC rates are above 5.5%, since the Fed Funds rate hasn’t move in the past couple years. But, maybe people are letting banks screw them. and capture a fat spread.

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2 Ryan

FS, a HELOC and and second mortgage are two slightly different animals; the difference is a second mortgage is a fixed rate loan, and a HELOC is a revolving line of credit. Interest rates can vary depending on a multitude of factors.

I don’t know the full situation (I didn’t ask), but the reader mentioned he recently refinanced his primary mortgage at a lower rate, so it’s possible the buyer wasn’t able to get the lowest interest rate when he made the purchase. So if he refinanced to a 5.25% loan, then it’s possible his primary mortgage was around 6% or higher when he bought his house, and his second mortgage was the 7.825% as he mentioned. Either way, paying the second mortgage off now (either in full or by making additional payments) can make a huge impact on his bottom line!

And for the record, I’m more interested in where he is getting a 1.9% interest rate on his savings! The best interest rates I’ve been able to find are around 1.65%. :)

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3 Financial Samurai

Gotcha. a 5-yr CD is offering 2.5-3% now.. so maybe that’s what he’s referring too.

7.825% is rough. He’s getting taken to the cleaners!

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4 Miranda

Even if he’s uncomfortable draining away all of his savings at once, he could still pay extra toward the principal each month, paying off the second mortgage earlier and saving money. As as Sam points out, he could probably find some sort of a refi to a lower rate to help things along.

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5 Michelle

The tax ‘savings’ of having that additional interest to write off (taking the 7.87% against the full principal of 28.8K) is $560 (assuming the 25% tax bracket) – the bank is offering a $500 bonus, which after tax (as this counts as interest income) would still leave only a “loss” of $288 in taxes to pay – which is less than 2 months of the 2nd’s payment…Duh. I can’t imagine NOT paying it off with the cash reserves – unless there are other factors (anticipated big expenses or imminent layoff).

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6 Michelle

I forgot to mention that my biggest financial regret/mistake was consolidating unsecured consumer debt into a $15K 2nd mortgage against my house (first mortgage balance was at $135K against a $200K-appraised house). After my husband was laid off, we weren’t able to keep current on our payments for a few months while he was job-seeking, and foreclosure was a real threat. Almost losing the roof over my family’s heads over $15K of credit card debt … absolutely crazy stressful. Needless to say, we pulled ourselves out of that hole and paying off that 2nd mortgage is my number one priority/ even over higher interest, lower balance obligations.

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7 Ryan

Michelle, That is the perfect example of when to pay off a lower interest loan instead of a higher interest loan. I’m glad to hear things are working out now, and I wish you and your family continued success.

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8 Michelle

Ha ha – my first comment got eaten…I ran the numbers on the so-called tax consideration. Taking full interest on the 2nd (2250 or so) for a year and assuming a 25% tax bracket, the positive impact of the deduction is a tax savings of $563 – even if you tax out the $500 bonus that the banks is offering as interest income, you’re gaining $375 – so the overall ‘loss’ for the year the 2nd is paid off is $188 in taxes you’ll have to pay. Why pay a year’s worth of $223/month to save $188?

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9 Don@MoneyReasons

If his primary job is fairly secure, I’d definitely pay off that 2nd mortgage…

For me, I get a certain level of satisfaction not having any debt (although I wouldn’t mind having debt for business opportunities).

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10 Manny

I have a home equity loan for $49,000 at a 8.5% interest, can’t refinance right now due to the drop on the housing market, my first loan is a 6% ( $199,000) I’m on my 2nd year of bancrupsy, so my credit score is none. any suggestions on how to deal with my situation, really need to get a better deal. Thanks

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11 fredct

Your credit score isn’t none, it’s low.

Sorry man, but it sounds to me like this is the consequences of having filed bankruptcy. Your paying high interest because you need to earn the trust of people who are lending you money again.

Your only option is being responsible – living below your means, putting away extra money, dropping unnecessary extras in your life, paying down your loans, and earning back the trust over time. There’s no magic bullet.

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12 Laura

I’m in almost the same situation, except my 2nd mortgage monthly payment is just under $200, and if I pay if off in less than 3 years from when I acquired it I have pay a penalty. The 3 years is up this May so I hope to have it paid off over the summer. If for no other reason but the psychological boost of now having it anymore!

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13 Joe

I have a 15 year mortgage with a balance of 113000.00. I’m in the seventh year of the mortgage 8 years left. I also have a 30 year second mortgage 6.9 two years into it. I was looking at refinancing at 3,85 percent plus 3000.00 in points for a ten year mortgage. It saves me money on the second but I know it costs me on the first. Combining reduces my payment 150.00 a month. Is it worth it?

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14 Ryan

Joe, It seems like it will save you a lot of money in the long run, especially if you continue paying the same amount you are paying now – that additional $150/mo going toward the principal will make a huge difference and probably knock a couple years off your total mortgage.

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15 Lee

Here’s an different twist… I have a 1st mortgage (fixed 4.875) with 114k left to pay over the next 9 years. I have a HELOC with a 324k balance (variable currently 2.25). I have enough money to pay off the 1st mortgage. Should I? I’d continue to aggressively pay down the 2nd – but it’s still interest only for the next 7 years so the payments could be flexible if need be. What are my risks? Tax disadvantages? Part of the HELOC is a business loan.

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16 Ryan

Lee, you have an excellent fixed rate on your primary mortgage, which would be tough to beat. The flexible rate is lower, but I don’t think interest rates will stay that low for long. It would be a huge gamble to do it.

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17 Ani

Hi, I have a 5% fixed primary mortgage (balance ~ 100K) and a second mortage (also fixed at 4.35% with a balance of 13oK); can I pay off my primary loan and retain my second mortgage? Would the bank allow me to do so?

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18 Ryan

Ani, I believe you can, but you will need to continue making at least the minimum payments on both mortgages at all times. If the bank won’t allow you to completely pay off the primary mortgage before the second mortgage, then you should be able to pay down the majority of your primary mortgage, then start making larger payments on the second mortgage when you have the cash flow to do it.

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19 Ani

Ryan, Here is the scenario I am working on: I am buying a new house and don’t plan on selling my exisiting house before closing the new house; in order to get a jumbo loan for my new house, I want to reduce my current debt by completely paying off my primary loan. That will leave me with the second mortgage on my current home. Can I do this? or I will have to pay off my second loan first before I pay off my first loan?

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20 Lynn

I have a first mortgage with a balance of 200,000 and a 2nd mortgage with a balance of 50,000. The interest rate on the first is 5.8 and on the 2nd mortgage it is 8.75. We really want to do something about the 2nd mortgage as the rate is so much higher and we’ve come to find out it was an “interest only loan” which we were absolutely not aware of, we thought it was a typical 2nd mortgage. We have been paying on the 2nd mortgage for 3.5 years and we have only shaved off barely 1000 dollars. Can you refinance just a 2nd mortgage? Are there companies that do that? I don’t think we can combine both as the housing market has taken such a fall and I do not think our home would appraise high enough and we would end up with PMI. Any suggestions? I feel like we are just throwing money away every month as the balance is going no where and the rate is way to high! Are personal loans available with better rates that we might be able to get and have a much better interest rate? Our credit scores are in the high 700′s. Thanks so much in advance for your response!

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21 Ryan

Lynn, you should be able to refinance your second mortgage if your credit score and income level support the decision. My recommendation is to contact your lender and see what is available. You may also be able to refinance your primary mortgage as well. Mortgage rates are near historic lows, and if you were able to shave a full point off your primary interest rate, you might be able to save a couple hundred dollars per month. If you are able to refinance one or both loans, you can repay your second mortgage much more quickly if you direct the monthly savings toward the principal on your second mortgage, potentially paying it off years faster than you otherwise would have. You can find some current mortgage rates here, and also be sure to check with your local lenders, as they sometimes offer great deals. Best of luck!

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22 Rad

Hi Ryan,

Thanks for the article. My second mortgage amount is $48K with 7.125% interest. I am planning to take a loan from my 401K to pay off the 2nd mortgage. Is it advisable? I checked with 401K, and the interest rate is 3.25% that I will be paying to myself.

Thanks!

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23 Ryan

Rad, I always recommend speaking with a professional financial advisor before taking a loan from any retirement account. There are several factors which may complicate the matter and make it inadvisable to do.

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24 fredct

I do *not* think this is advisable.

Two key reasons – first the interest rate on a 401k loan is misleading and basically irrelevant. As you said, you’re paying it to yourself. What *does* matter is that the money won’t be in the 401k any longer earning you anything. Your 7.125% tax-deductible interest rate is more like 5.3% because of the tax savings (assuming a 25% bracket – personal details may vary).

It’s certainly no large stretch to think that the market over the next while may return more than 5.3%. It may not, but what you need to compare that 5.3% to is the return of the market, not the irrelevant 3.25% ‘rate’.

Second, 401k loans are risky because if you are laid off, decide to quit or change jobs, you owe the entire amount back in a very short time frame, or the entire thing becomes taxable income. Tax on $48K (on top of your regular income) will almost certainly be $10K, plus 10% penalty ($15K plus). If you can’t make your payments, similar things happen. So I would be very hesitant to ever take a 401k loan, unless you know you can pay it back in full immediately if you lose your job.

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25 melanie

My hubby and I have an interest only primary mortgage owing 399,000. We also have an interest only HELOC in which we owe 73,000. We have an additional 1,800/month that we can pay on either of the mortgages. Which one should we put the 1,800 on? The HELOC or the primary mortgage?

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26 Ryan

Melanie, my first recommendation is to try and refinance your loans to a traditional fixed rate loan. This is the only way you will pay them off in a reasonable amount of time. Now is a great time to refinance because mortgage rates are near all-time lows. Here are some current mortgage rates if you need to get a quote.

If you can’t refinance, then you need to consider other factors of your loans. For example, what are the interest rates, do they have a balloon payment coming up, can you get them to the point where you can refinance them, etc. Then direct your funds toward the better situation (for example, if you can refinance your HELOC once you get it below a certain point, then pay extra there first, or vice versa).

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27 melanie

Hi, I cannot refinance either loans. So in my present situation, which should I place the 1,800 on? SHould I apply the extra towards the HELOC or the primary mortgage?

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28 fredct

The answer is: we don’t have enough information.

The first question is, do either of them have a balloon payment or any big cost increase coming soon? If so, that should very likely be your priority.

Second, the answer may be neither. What other priority do you have? How is your retirement savings going? Do you have any other debt or loans? Any big events upcoming you should have for? Do you have a sufficient emergency fund? Basically, I’m asking, why are you so sure that paying down a mortgage is the right answer? Are there other things you haven’t considered?

Finally, lets say that paying down the mortgage is the best of your money, and there’s no special considerations like balloon payments to worry about… even then, we don’t have enough information. The key missing piece is what are the interest rates on the loans? Generally, the higher interest rate will be the better one to pay off.

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29 melanie

My HELOC (interest only) has an interest of 6.75%. My Primary mortgage (interest only) has an interest rate of 5.75%. There is no balloon payment, but I assumed that it may be the best idea to get rid of the HELOC since we could probably pay it off in three years by adding an additional $1,800 month. However, our interest rates on our primary mortgage will change every 6 months. My hubby and I do not have any other debt. We should be retiring in approximately 20 years, and I think it would be in our best interest to get rid of these mortgages. So with this additional information, which should I pay first–the HELOC or primary mortgage?

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30 fredct

Well, if you were to pay one off, it would certainly be the HELOC, which is at a higher rate (the most important factor), plus the fact that the payment will rise when the IO period ends.

However, I would question if you really want to put that much per month towards that, or if you have other goals you should keep in mind too. How well is your retirement funded? Are you maxing out IRAs? 401(k)s? Do you have college you need to be saving for?

Since you have secured, moderately low-rate debt (i.e. not credit cards at 18-30%), I don’t see a need to be putting that much per month at it, if you have other needs also.

Unless your retirement accounts are all maxed out, and you feel very comfortable with your other long term goals, you should probably split that extra $1800 and not throw it all at one place.

31 melanie

Additionally speaking, if I pay off the HELOC, we will be in a better position to refinance our primary mortgage.

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32 JeffK

Hello, would like some financial help please. I just finished an 85,000.00 credit card consolodation loan for medical expenses for my daughter, took us 5 years, but we didn’t file bankruptcy..we paid it. We have a first mortgage of 181,000 at 6% and a second mortgate of 34,000 at 11.875%. We only have additional debt of 22,000 in unsecured left. The wife just got a year end bonus of 35,000. Our home will probably not appraise for the 181,000 on the first mortgage since the market fell, so I don’t believe we can refinance at this time. Our second mortgage payment is 585.00 and the unsecured debt is about 800.00 a month. Where do we best use the extra 35,000? Jobs are secure and we have a good 6 months in savings at this point. Many thanks! Jeff

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33 Ryan

There are several ways you can do this, but I would consider trying to eliminate your 2nd mortgage before your unsecured debt. The reason is because once you eliminate your second mortgage, you will be closer to being able to refinance your primary mortgage if that is something you wish to do (this might not be a bad idea with rates as low as they are).

Another reason I would try to eliminate the 2nd mortgage is because doing so should reduce your credit utilization, which will increase your credit score and make it easier to be approved for a 0% balance transfer credit card. Then you can transfer your credit card balances to a 0% interest card to repay those loans more quickly.

After that, I would use the debt snowball method to begin eliminating your debts as quickly as possible. Best of luck!

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34 fredct

The one factor you may be missing, Ryan, is interest rate. If the unsecured debt rate is very high, say 20%+, then you’d get more back for your money by paying that down. For instance, if the unsecured is 25%, then for every $1000 you put into it, you’ll save $250/yr.

For the home at 11.875%, for every $1000 you put into it, you’ll only save ~$119 per year… actually more like $70-$100 because of the effect of the home interest tax deduction.

In this particular example, you’re saving yourself $150*35 = > $5000 more per year by paying off the unsecured instead of the house.

If, on the other hand, you have done a 0% balance transfer or something else to get your unsecured debt at a low rate, then the mortgage pay down begins looking like the more tempting option.

From a pure math perspective, the best debt to pay off is the one with the highest rate.

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35 Ryan

Fred, I thought about that, and you bring up a good point. But I was also thinking about the 0% balance transfers, because he mentioned he recently paid off a credit card consolidation loan. Because he just paid of $85,000 in debt, he should have decent credit and high credit limits. Paying off his 2nd mortgage should lower his credit utilization by quite a bit, which might make it possible to qualify for another round of 0% balance transfers, ultimately saving more money in the long run. Plus he would eliminate a secured debt, vs. a non-secured debt, which would make me sleep better at night.

So, yes, higher interest rates are better mathematically, but depending on the circumstances, it could be better to do it another way (though I admit my way doesn’t work if he can’t qualify for a 0% interest balance transfer). Of course, this is all speculation, and should be considered thoroughly before any action is taken. :)

36 fredct

Fair enough, if he qualifies for 0% interest, it can make a lot of sense. The only warning I’ll give – and a reason that holding secured debt may make me sleep better than unsecured – is that the rate on secured debt is usually fixed, or very near to it. While on unsecured, if you miss one payment – even just due to forgetfulness – it’s very possible you’ll find your 0% back at 25% overnight.

There are certainly pluses and minuses to each, and I think the two of us have done a good job laying them out.

Lastly though, I’ll mention that paying off the unsecured debt would have a similar or identical impact on his credit utilization ratio, so long as he leaves the cards open after paying them off. Which may or may not be in his plans.

37 Lynn

Can anyone recommend a good company to work with to refinance a 2nd mortgage? I am having a hard time finding lenders that refinance 2nd mortgages. Any suggestions would be appreciated. The amount is 50k and rate is 8.75 and I know we should be able to find lower rates right now. Thanks!

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38 Paul

Here is my question – I have a 1st mortgage at 4.6% on $345k and 2nd mortgage at 8% on 33k (pool loan). I bought the house in 2005 for 552k, now it is probably worth 375k…ouch. I have 80k in non-ira/retirement accounts and my job/business is very stable – should I pay-off 33k 2nd loan or just pay the $232 payment each month? My total mortgage payment is $2300 and I am in the 28% tax bracket.

Thanks for your advise!

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39 Ryan

Paul, you also need to consider whether or not you will have to pay capital gains taxes on your non-IRA/retirement investments if you cash them out. Paying taxes on those investments could cost you a lot of money both now, and potentially in the future (missing out on potential future gains). Paying off 8% interest doesn’t do you much good if you are paying 15% or more in taxes to save 8%. Your investments also have the potential of earning more than the 8% you would be paying. Run the numbers and decide which situation works best for you and your risk tolerance. Best of luck!

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40 Christine Smith

I need to know what Federal Law or Senate Bill for California I can use to inform the 2d mortgage that they cannot request to see my 401k statement due to my Short Selling my property through the first mortgage bank. I am a Real Estate Agent in California and have been told by several other agents and lawyer clients that they cannot ask for that information. I’ve left a message with one Bankruptcy Lawyer asking if she can provide something in writing that will give me the affirmation to the statement ‘you can’t ask for that information’; but, she has not returned my call of several weeks ago. Thank you for your time and information.

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41 fredct

I believe was you’re looking for is ERISA which protection ‘pension’ plans from creditors, including 401(k)s, as confirmed by the 1992 Patterson v. Shumate Supreme Court ruling:
http://www.law.cornell.edu/supct/html/91-913.ZS.html

I suppose nothing stops them from asking to see it, but it’s a waste of their time, considering they can’t take any of it.

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42 Christine Smith

Thank you so much. At least I can quote this to them. Really appreciate your assistance. This empowers us to protect our clients from the 2d Mortgagor in a Short Sale. Thank you, thank you, thank you.

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43 Heather

I have 117000 first mortgage t 6.75% and 21000 snd t 15.69%. I can refi the first to 4.75% and payoff the second but it will take every bit of savings I have but it will also save me 600 a month. What do you think?

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44 fredct

I’m nervous about you saying it’s “every bit of your savings”. You should really have a few months of emergency funds sitting around, in case something were to happen (job loss, urgent car or home repair, etc) that causes you to need some cash fast. Putting yourself right on the edge like that with no savings is very dangerous.

Also, when you talk about “every bit of savings”, does this include retirement accounts? If so, you would have to consider the taxes and penalties you would need to pay to free up that money.

Overall it sounds like you could save a lot of money, but I don’t like the idea of cashing out retirement accounts (if that’s what you mean), or of leaving yourself without an emergency fund.

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45 Raghu

Hi,
I have a rental property, on which i have a first mortgage of 517K, and a HELOC of 250K. The house is currently valued at 700K. I have an interest rate of 5.25% 5/1 arm on my first. My heloc is at 3.25%. I secured the 5.25% on the first mortgage when it was still my primary home. the 5 years on the 5/1 arm is due for the first interest rate adjustment in nov 2013. Since the interest rates are very low right now, i want to refinance my first mortgage, I cannot do that, because i have an HELOC of 250K out of which i owe 225K. I have emergency savings of about 85K. I am planning to pay of the 225K in the heloc, with about 100K coming form stock option sales (I am in the 40% tax bracket, including the 11% state tax bracket), which means i need to sell about 150K worth of stock options to get 100K. another 100K form money borrowed form mine and my wives 401K (50K each). And 25K form my emergency funds. All this in a hope to secure may be 4% on a 5/1 arm or a 5% on a 30 yr fixed on my First mortgage. Is it worth doing this?. Thanks.

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46 Ryan

Raghu, the only way you can know for sure if it is worth it is to run the numbers. We are seeing near historical low interest rates for mortgages, which is nice, but no one knows how long they will last. If you refinance, it would probably be best to go for a fixed rate loan, since we don’t know what future interest rates will be. A lot can happen to interest rates in 5 years, and it’s possible that getting a lower ARM now may come back to haunt you in the future, especially since it can be more difficult to refinance a rental property than a primary residence (and rates for rentals are sometimes higher as well). I recommend meeting with your financial advisor to better understand your options now and how this move fits into your broad long term financial plan.

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47 Catherine

Like the original letter writer, I have a 2nd mortgage I’m debating paying off. I don’t have as much in savings as he does, however, but I’m looking to refinance the 1st mortgage and even then I’ll be lucky to have 80% equity in this market.

So, refi or no refi, here are the stats:
1st mortgage, $245K at 5.625%
2nd, $15K at 7.625 % (I made an additional payment of 3K recently)=$134/mth
Savings=$36,000
Job looks secure
No other debts. Car paid off. Pay credit cards off every month.
Is it worthwhile getting rid of the 2nd mortgage given that I’d then only have $20K in the bank? I’m single with no kids (at this point).
Thank you.

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48 Ryan

Catherine, it’s tough to give a full recommendation based on the information at hand. For example, $20,000 in the bank might be plenty of money for someone with a fairly secure job and low monthly expenses. On the flip side $20,000 might not seem like much for someone whose job is in jeopardy or or for someone who has high fixed monthly expenses.

That said, I am a fan of paying of debt as quickly as possible, provided it doesn’t put you in a difficult financial position. If you feel secure with $20,000 in the bank and can use your monthly savings to add more back to your emergency fund/savings account, then it might be a good idea to eliminate the 2nd mortgage.

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49 fredct

Yeah, I think Ryan hit it right. At that rate, it’d be a fairly good thing to pay it off, but it’s not an awful rate either, so it’s not critical. If you think your savings and your assets are sufficient that you would sleep well at night having paid it off, go right ahead. If you want more of an emergency fund based on your job and other particulars, that’s an understandable choice.

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50 Catherine

Thanks both of you. Job *seems* quite secure. Paying it off should increase my credit scores, correct?

I figure if I really needed more money, I could sell assets such as car, or possibly borrow from the old folks and pay them better interest than they’re getting now.

51 Catherine

Update: I’m in the processing of refinancing $245K at 4.5% with no points. I have to pay off the 2nd mortgage to get that rate (and yes I’m aware I probably could have done a bit better this week).

My one question is about the “condo penalty” for Fannie and Freddie-backed mortgages. My lender says it’s a mandatory .75 point fee, or the equivalent in the rate (1/4%). When I called another lender, they didn’t know what I was talking about. But their fees were higher.

By the way, my mortgage is backed by Refi Plus, so it doesn’t matter that the equity has eroded with falling house values. (Nowhere near underwater.)

52 SK09

Hi,

I have a decision to make on my home equity loan and would appreciate any advise.

I bought a condo in 2006 in orange county, california, put 0% down and got two loans, one a 30 year fixed (300k – 4%) and other a home equity loan (100k – 7%) that matured in 5 years. The property value fell by about 100k over the last 5 years.

Now the home equity loan is maturing soon and the bank is willing to refinance my home equity loan. I also have the money to pay off the 100k home equity loan. But i have a family now and need a bigger home.

Would you pay off the home equity loan and loose the money (home is valued at 100k less now) or refinance the home equity loan and use the money as down payment for second home?

I’m thinking of reducing debt and risk loosing that 100k (hopefully the home values goes back to it’s original value someday). Thoughts/Advise?

Thanks

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53 SK09

Hi Ryan,

Any suggestions for me? I would appreciate your input.

Thanks!

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54 fredct

SK09,

You seem to be mixing a lot of topics together. The most important thing I want to point out is that the 100K is already gone. Whether or not you refinance, or way you do, it already is. I just say that because I don’t want you making a decision based on trying to ‘save’ that money. What the house is worth is completely independent of your financing choices.

Second, I’m very surprised of the idea that you could take the money out. If the house is worth $100K less now, I don’t see a bank refinancing you above the actual value. Banks would hardly do that during the boom, but nowadays they’re quite conservative.

Finally, all the talk about refinancing doesn’t seem to make sense if you’re planning on selling & upgrading anyway. Refinancing generally carries with it closing costs that you wouldn’t have time to recoup. So if you’re going to sell and upgrade (assuming you can afford it), then make your life simpler and don’t throw all those extra steps into it.

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55 SK09

fredct,

Thanks much for the reply. I guess I was not clear in my question, my apologies. Although i’m under by 100k in home value, wells fargo is willing to refinance my 2nd loan, they own the loan today (home equity loan – the 96k that remains on that loan). And i plan to go ahead with that refinance.

Ideally i would like to retain this property (rent it out) and buy a second bigger home. But the rental income will not cover the two mortgage payments, so i will have to pay out of pocket. Do I use my personal savings (100k) to reduce my mortgage payments on this home (will lose that money as the house value has reduced) ….do i rent it out and use my personal savings as down payment for a bigger place.

If this is confusing or not clear, my apologies.

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56 Ryan

SK09, it’s tough to answer the question without knowing more about your entire financial situation; things such as income, cash reserves, job stability, monthly cash flow, monthly expenses, etc.

I recommend sitting down for a few hours and mapping out your financial plan and your current financial situation, then determining if maintaining another property fits in with your long term financial goals. If it does and you can afford to maintain the negative cash flow on a rental without harming your financial goals, then you may be able to make a case for keeping the other property. But if keeping the other property doesn’t fit in with your goals or it would make things too difficult in an emergency, then you may need to reevaluate your plans.

An option that might be less risky is to keep the current house and rent it out, while covering the difference from your cash reserves or current income. Then rent a home for your personal use instead of buying a new home right away. This will give you more financial flexibility in the long run because it is usually much easier to scale down from a rental than it is with a home (as you have seen with your current home). This will give you time to evaluate the effect of the negative cash flow caused by renting your home for a loss, and possibly give you more time to build a larger cash reserve for reducing your current mortgage and/or making a down payment.

57 Thomas

Hi I have a house that is rental property in Minnesota and has a 1st with 145K at 5.25% and a second with 50K at 9.25 as a balloon with 44K due in 2014.

I also like the previous person have about 4 months of living expenses as an emergency fund. I also have no other debts other than the rental property. I pay out $350 to cover both mortgages every month. The house is at the water line for LTV or about 95%.

Is it wise to pay down the 2nd or use the money to save for another property here in California or try and sell the house long term?

Thanks, Tom

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58 Ryan

Tom, right now interest rates are at or near record lows and it may be possible to refinance your mortgage and save a lot of money in the process, especially if you can refinance your second mortgage to a fixed rate without the balloon payment. As far as searching for another property, I personally wouldn’t take on any more risk until I had a definitive plan in place regarding how I would resolve the balloon payment on that second mortgage. 2014 isn’t too long from now to come up with $44,000. So I would either try to refinance that portion of the loan, sell the property, or begin saving so I had the $44,000 in the event the balloon payment became due.

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59 Jill

Hello — and thanks in advance! We have a two loan scenario on our house. The first mortgage, is $276,678 @5.365% and the second is an equity loan of $52,685 @ 11.5%. We’re unable to refinance the second loan because we don’t have enough equity in the house to do so. The 11.5% just kills me, and I’m considering “borrowing” from contributions made to a Roth IRA. I need to bring about $20,000 to the table to refinance as one loan of about $310,000 for 4.1%. This huge savings would allow me to max out contributions to my Roth (currently not doing this) and would save a huge amount of interest. Does this make the most financial sense? There would be no tax penalty/interest if I simply “borrow” from contributions made, right?

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60 Ryan Guina

Jill, there are several factors to consider, including the 5 year withdrawal rule for Roth IRA contributions. Basically, the contributions must have been in the Roth IRA for at least 5 years before you can withdraw them tax free (and you can only withdraw contributions, not earnings). Here is more info on Roth IRA Withdrawal Rules.

As for whether or not this is a sound strategy, a lot of it depends on your discipline. If you can refinance at a low enough rate, save enough money each month to max out your Roth IRA each year, and you stick to that plan, then it may be worth it in the long run. Keep in mind this will definitely set your retirement back a little bit, but if it means you have more cash flow and aren’t struggling to make your mortgage payments, then it may be worth it in the long run.

Because IRA withdrawals can be tricky, I strongly recommend meeting with a financial professional to go over this plan with you to help you run the numbers, determine the best course of action, and ensure you make any withdrawals correctly to avoid any tax surprises. A financial professional may also have other recommendations, so it’s definitely worth the minimal investment of time and money.

Best of luck!

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61 luke

Thanks in advance for your advise. We have a rental property that we purchased in 2007. 1st mortgage at 175k @ 5.25% / 2nd 22k @ 7.5% .. And the property value is now about 180k. We have cash savings of around 60k, and are thinking of paying off the 2nd. Option 1 is to use $ from our savings. Option 2 is to reduce the % we put away to our 401ks down from 15% to 6% to ensure we continue to get company match and apply the savings to the monthly 2nd payment. Option two would take us about 15 months to pay the 2nd off. I work in the High Tech field / job ‘seems’ secure but its could be a ?? every year. Your thoughts on the best option? 1 or 2?

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62 Ryan Guina

Both options work, but it depends on what you are trying to accomplish. If you use your cash savings to pay off your second mortgage, you will still have a sizable sum of cash in reserve for any emergencies which may arise, and you can pay yourself back with the monthly savings from the money you are no longer contributing to the second mortgage. I would run the numbers and see how long it would take you to pay yourself back in that scenario. Another possible benefit of paying off the second mortgage now is that it may make it easier to refinance your home under some of the programs that are available right now. If you are able to refinance at a lower interest rate, then you may be able to save even more cash flow each month, which you can use to rebuild your cash savings, to pay off your mortgage early, or to pay other debt.

Reducing your retirement contributions is another possibility, but take a few moments to look at your total situation before going that route. Are you making good progress toward retirement savings, can you afford to reduce contributions for two years, are you retiring soon, or do you have a fair amount of time to increase your retirement savings down the road?

On a personal level, I am a big fan of getting rid of obligations that tie up cash flow, so I would be interested in eliminating the mortgage right away – but only if I had enough cash left over to handle any financial emergencies which might pop up. But in the end, this needs to be a personal decision based on your specific situation (which includes much more information than can be covered in a quick blog comment). You should run the numbers and decide which option is best for you. Best of luck!

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63 Candy

Ryan, help! Just got a call from the bank that my second mortgage(line of credit) is being called in, evidently it had a time limit. The mortgage is against my vacation rental property that I own in Fl. How should I pay it off? Use a chunk of my 401K? Borrow from my credit union? Borrow from my bank? I’m under 2 years from retirement and am 62 years young.
Can you make a recommendation?
Thanks, Candy

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64 Ryan Guina

Hi Candy, you have a complicated situation, and since you are so near to your retirement I recommend speaking with a professional financial planner. It’s important to look at all options before making his decision, and a financial planner can help you look at various options and help you understand the impact of each option. He or she will look at your total financial situation and help you decide on the best course of action. Best of luck.

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65 adam

here’s my situation; would appreciate the help any insight.

aside from a primary mortgage, i currently have a second mortgage at 8.25% fixed (15 year balloon maturing in 2028) and an auto loan at 3.49% (47 months left on this). Both have nearly identical principal amounts to payoff ~$22,700. monthly payment on the 2nd mortgage is $182.10; for the auto loan it’s $506.

i’m going to be receiving a windfall that can pretty much payoff one of these debts.

my question: which one should i pay off? i was thinking second mortgage simply because it has a much higher rate, however tonight i was thinking about paying off the auto loan first since it has a much higher monthly payment, then redirecting those monies as additional principal on the 2nd mortgage.

i realize if i did this that i’d end up paying a couple thousand in interest over the next 2 years on the 2nd mortgage while i pay it off, however what i’d gain is the cash flow flexibility of eliminating a $506 payment per month. a couple thousand over the next 2 years isn’t going to kill me and from a risk perspective, it reduces my monthly debt requirements almost 3x more than if i eliminated the mortgage ($182 vs $506).

thoughts?

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66 Ryan Guina

Adam, I’m a huge fan of cash flow and the financial flexibility it gives you. If you eliminate your car loan and free up $500 a month, you have the ability to send that money toward prepaying your second mortgage, investing, or building a cash cushion for emergencies. I would lean in that direction if you are certain you won’t be in danger of defaulting on your second mortgage, since the penalty for defaulting is foreclosure. If that doesn’t seem to be an issue, then the extra cash flow could be huge and allow you to pay off your mortgage much more quickly.

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