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Chat Plus: Pay Off the Second Mortgage or Save the Cash?

Here's a question remaining from last week's Real Estate live chat:

Northern Virginia: We bought our home in 2006 for $775,000. While we are in good standing with our mortgage, we are "underwater." (Homes of similar age/size/condition in our area are currently selling for about $600,000-$650,000.) We want to relocate out of the area but do not have the funds to make up the difference. We assume it will take three to five years for us to break even, maybe more. We determined that in three years, we could pay down our second mortgage enough to account for the current drop in value. Do you think this is our best option to accelerate our ability to move? Or do you think it's better to save our money for the future sale, closing, etc. and pay any possible difference at that time instead?

E.R.: Of course, a lot depends on the interest rate you're paying on that second mortgage, but with all the uncertainties remaining in the economy, I still take comfort in building up cash. And, given the decline in your home's value, you would not be able to access home equity credit should the need arise.

It pays to plan for the unexpected. You might need some of that cash to tide you over in case a layoff or illness hit, for example. And your relocation plans might change. This is one of the many instances in which it's wise to look at housing options within the broader context of your overall finances. Are your emergency savings adequate? Is too much of your wealth tied up in real estate or the stock market? If you have the money in the bank, you can, as you indicate, use it to pay off the mortgages when you eventually do sell. If you pay off the second mortgage early, you've boxed yourself in.

By Elizabeth Razzi  |  August 25, 2009; 6:00 AM ET
Categories:  Chat Plus , Mortgages , The market  
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We've been doing something similar. When we redid the back half of the house, I had a plan to have the HELOC paid off within 5-6 years, by paying 2-3X the required monthly amount and putting at least half of my end-of-year bonus toward it. But we were also building up cash reserves again -- between our 20% downpayment in 2004 and the remodel a few years later, our cash-in-hand was pretty drained, just as the economy turned (of course). When things got bad a year ago, I started to fret.

So DH suggested we back off on the prepayments. I hated that idea. But low interest rates had dropped the HELOC from @ 8% down to @ 3%. And given our relative lack of cash, it was hard to argue. So we cut last December's big prepayment check in half, and put the rest into a money market. We did keep the monthly prepayments (even though my salary was cut, I couldn't bring myself to not pay SOMETHING off), but all other "extra" money goes into the money market (tax refund, extra $$ from maxing out on FICA, etc.).

My hope is that by this winter, we will have built up enough of a cushion that we can re-start the big annual prepayment (if I'll even have an end-of-year distribution to contribute!!). But the good news is that our HELOC is currently only at 3.5%, so as long as interest rates stay low, we're not really losing that much on the extra HELOC interest.

One thing I will note is that psychologically, it seems to hurt less to walk away with nothing from closing than to bring a check. So, yes, logically, it may be better to have $200K in cash, which you can use to pay off the underwater mortgage if you have to move, than to have no cash but owe $200K less. But how is it going to feel to write a check that big, and watch your bank balance go down to zero after working so hard to save it up? And will knowing that you are going to have to write a big check influence you to do counterproductive things like list your house at an unreasonably inflated price? That's part of the reason we're continuing to prepay; I will just rest a lot easier when we are no longer underwater, and I know I can walk away clean if I have to (really really really don't EVER want to sell, but DH has been laid off and had plants close on him 3 times since '98, so never say never).

Posted by: laura33 | August 25, 2009 12:31 PM | Report abuse

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