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).
Regardless 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 the 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.
Consolidating Your Mortgages into a Single Loan
The next best option is to consolidate your two mortgages into a single loan.
This makes sense if you do not have the funds to go ahead and pay off the second mortgage in a short period of time. The obvious benefit being a much lower interest rate on the second loan.
Some of the top options for consolidating your loan are:
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 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?
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