[UPDATE: Operation Mortgage Pay Off is in full effect now!]
Hey guys! So you know I’m working on my new Mortgage Pay Off Plan, right? Well, I have a ton of good ideas on how to actually make this happen, BUT I’m currently stuck on something key here, and I want your input. Like, seriously – I’m not just saying that to make for an interesting blog post :)
Here’s the deal. Right now I am 100% debt-free except for our mortgages, and I absolutely can’t stand it any more. We got a head start with refinancing the other month, but my plan of “dealing with it later” regarding actually PAYING IT OFF has gone on for a good 4 solid years now, and I’m over it. It’s now time to actually DO SOMETHING about them – my only problem right now is that I’m stuck on *which* mortgage to concentrate on first?
I’ve ran a whole bunch of calculations, using some awesome mortgage calculators for like 2 straight hours, but the only variable standing in my way is that my 2nd mortgage has a VARIABLE rate! haha… and I don’t know what the Fed is gonna do over the next handful of years while I start implementing this new game plan of mine.
Here’s a refresher on our stupid mortgages: (yes, I’m still bitter about it, even though it’s totally my fault we’re in this mess to begin with ;))
- 1st Mortgage: $289,203.65 – 30 year conventional @ 5.5%
- 2nd Mortgage: $61,907.88 – Maxed out HELOC @ a variable 2.8%
And the way I see it, I have two options here. Or, maybe even 3…
- I concentrate on the 1st mortgage 100% since it has the highest interest rate @ 5.5% – Almost DOUBLE that of the 2nd mortgage! Factually, this is the smartest route to take. At least at this given moment in time.
- I concentrate on the 2nd mortgage 100% since that variable rate, in theory, could inch up any damn time it pleases. With this market, and the Fed saying they’re gonna leave the rates super low for the next 2 years, it *seems* like we’re still a ways off until that happens, BUT legally/contractually I’m on the hook if it triples over night. On the other hand though, this lump sum is only 1/5th of the 1st mortgage! Meaning I could knock it out MUCH faster, and have that good “win” under my belt continuing to motivate me even more.
- I pay off some combination of both mortgages – evening out my risk. This may make the most sense out of all of them, but to be honest, it just bores the $hit outta me. I like to go All In or nothing, baby! Haha… which adds an entirely different level to my financial planning of everything ;)
In case you couldn’t tell, I’m currently leaning toward option #2 the most. Though only by a little bit – maybe 10%? Part of me feels like if I can pay it all off entirely by the time the rate goes up, I would have gotten out just in time and saved a ton of heartache (and money). But on the other hand, if it took me, say, 5 years, then that’s 5 years I could have been paying off the 5.5% interest the whole time saving me even MORE money! Which is also kinda crazy if we’re strictly basing it off financials. Argh… see, this $hit is hard, even for us bloggers :) Too many options and no “Right” answer! Haha…
So that’s what my thought process is at the moment. Mrs. BudgetsAreSexy is cool with either route really, and is pretty much just leaving it up to me. So now I need YOUR help. And I can easily be convinced either way if you smarty pants make an epiphany go off in my head :)
And for the moment, just forget about any #’s as far as how much extra we’re gonna pay off every month, etc. That part’s important, but it doesn’t affect the decision on which to pay off first I don’t think? Plus I’m still working on that. Just pretend it’s a lot more than paying $100 extra every month like we’ve been doing! I don’t even wanna know how many years THAT would take to get rid of them both, bleh…
Okay, so your mission right now: What would YOU do if you were in my shoes? Do you see a clear cut answer here, or is there something *else* we’re not even considering? Tell me, I can’t wait!! You could very well change the course of our entire financial lives! ;)
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I say go for option 2, paying off the second mortgage first. Doing that goes along with Dave Ramseys debt snowball and I think that’s what he would tell you to do too.
I agree with Michelle Singletary on this one. Pay off the smaller balance first. The psychological feeling that comes with an entirely paid off debt is a tremendous motivator. Just think how great it will feel to say that you paid off an entire mortgage and only have one left!
Yeah go for option #2 knock out the smaller one first. I’m all about risk mitigation and I “snowball” all the risk in my life and finances. So yeah definitely take down that variable son of a….
I would focus on the first mortgage, since not only is the interest rate higher, but the balance in higher. And then just keep an eye on the second mortgage and switch up your gameplan if the interest rates rise.
Then again, I can totally see why you’d want to go with option 2, to get that “win,” but since it’ll probably take you a few years just to pay that sucker off, I can’t imagine it’ll give you the same win as, say, paying off a $5000 credit card bill and then moving on to other debts, you know? If you want to go the snowball route, why not mentally break your mortgage debt into sizeable chunks. So like, instead of focusing on mortgage number one or number 2, focus on paying down $10,000 worth of debt. And then $15,000. And then $20,000. And do the snowball that way. Just my two cents. :)
I would put the extra money towards Mortgage #1. Using estimates of a 30 yr loan starting today with your mortgage amounts and rates (which I know youve paid down over 4 or 5 years already), then that means mortgage #1 is costing you $1300 a month or so in interest while #2 is costing you $140 a month in interest.
I would probably focus on the second mortgage. Most of the second mortgages I’ve seen have a balloon payment at 10 or 15 years, although I expect you would have mentioned that if it was the case with yours.
I’m actually in a very similar setup right now – not with two mortgages, but with a mortgage and student loans. The mortgage is fixed at 5%, and the loans are variable at 3.1%.
My suggestion is simple: focus 100% on whatever has the higher rate. Right now, put everything towards mortgage #1, and if interest rates spike, switch.
I am all for focusing on the first mortgage. You clearly already have the motivation to start knocking these debts out, so the priority is what will save you the most money in the long run. For the foreseeable future (as if anything really was foreseeable) you are getting a 2.7% return on the money you are socking into the first mortgage. If you start seeing a bump to that variable rate in a month or a year, you can just flip the switch and start hitting that debt just as hard.
I’d pay 100% on the higher rate first mortgage. The variable rate is not likely to rise quickly and if it does start going up, you can always switch off your extra payments to that. It will save tons of money in the long run.
I’d pay most of the extra money on the first mortgage with payments to the second something to pay it off in a reasonable amount of time. The fed just tipped their hand to say they’ll be keeping interest rates low for the next two years so the HELOC’s rate probably won’t be going anywhere fast.
I’d say first mortgage, then switch if rates start to trend up. Not sure how much extra you can put towards the 2nd mortgage to make it a “quick” win, so paying that one off still might take a while, so focusing on the higher interest rate loan will save you the most money in the long run.
I say screw both of them and sell the house. Mortgage rates are so damn low right now as are houses. You could probably get a cheaper house and a lower rate! Just my two cents haha.
The first mortgage should be the priority. It has a higher interest rate, higher balance, and longer term, all resulting in exponentially more interest that the HELOC. You don’t need the motivation of the ‘win’ by paying off the lower balance first. You have proven you are motivated by being debt-free (other than mortgage) and being a finance blogger. You should do the smarter move as far as money goes.
The only thing that would change my response would be if you have a pre-payment penalty. You want to verify you don’t. Also, if the HELOC rate starts to inch up (though hopefully there are some periodic caps in there), you can always switch your plan once the rate exceeds that of the first mortgage (again, being mindful of any prepayment penalties).
I manage a branch of the largest home lender in Ohio. Mortgages are our thing. just sayin…
What would you suggest on a flipped deal like this:
1st: 550k 30yr 3.5 10/1 (so I’ll refi that within 10 yrs)
2nd: 65k 30yr 5.5 fixed
Right now I’m throwing more at the 2nd. Appreciate the input.
I’d like to add this: for an extra $500/month, and assuming I can refi at 3.5 fixed on the 1st (which I know is probably a bold assumption at this point):
I’d save 96k on the 1st vs 50k on the 2nd (total payments reduced 889k->792k and 123k->73k respectively).
The 1st is paid off in 22.25 years, 2nd in 7.75 years. So the total $ savings is more on the 1st loan being accelerated.
However I could start applying that extra $500 + the min payment on the 2nd ($360) towards the 1st after the 2nd is paid off, for the duration, basically keeping my monthly payments the same. If I did that, I’d be at ~458k balance on the 1st at the time of the 2nd payoff, and would save a further 72k and the 1st would be paid off in 22 years.
With this plan it seems my potential total savings would be 72k + 50k = 122k AND I’d own the place within 22 years, as opposed to 96k and 30 years.
Looking for confirmation that I’m not crazy but please also feel free to tear apart my maths if I’m off. Thanks again.
Option #1, definitely.
Have you ever read Predictably Irrational?
It doesn’t make sense to pay off a lower debt rate, even though it will “feel” better. All signs point to interest rates staying low for a long time, so you can expect your 2.8% rate to stay lower than 5.5%. Does your Variable Rate have a max % increase in any given year? That will help as well.
I suggest laying out both mortgages amortization schedules and evaluating them side by side. You didn’t mention the term length of your HELOC. Is it 30 years? I suggest starting with how much extra cash you can throw at your mortgages. If your HELOC is only 10 years and you want to be free from mortgage debt in 5, then adjust your payment on the HELOC to pay it off in 5 years. Then start throwing the rest of your extra cash (and any extra pennies you can manage) at the first mortgage. While it’s not all or nothing, you’ve identified a “Mortgage Debt Free” date and are pragmatically moving toward it by adjusting the smaller balance to be paid off by that date. The challenge will be to scrape enough money together to be crazy and hit that Mortgage Debt Free date with the first mortgage. Give yourself a major stretch goal here.
I say go with option #2, for sure. Dave Ramsey would approve, but it’s also what I would do. Interest rate schmenterest rate, I’d rather have just one mortgage. Any chance of also refinancing that first to a 15-year fixed at a lower rate? Generally right now rates for 15-years are in the 2-3% range!
Second mortgages…ughhh…I see them in bankruptcy all the time.
I would go with option #2 because I think getting rid of a creditor completely is always a good thing. Not to mention you can get rid of it more quickly AND it does have a variable rate (no matter how low that rate is right now). Because I don’t have a second mortgage, I’m not familiar with the tax breaks one gets for one? Do you still get to write off that interest? Either way, the 2nd is giving you less of a tax write off than your big mortgage since it has a lower interest rate, so I think that would also benefit the side of paying off the 2nd first.
So poorly written, hope it makes some semblance of sense.
Option #1: Absolutely put extra payments toward the 5.5% loan. It’s purely mathematical. The “win” is that you are making your money go farther with no extra effort on your part. Obviously, in the unlikely scenario that your 2nd mortgage rate goes up, you would change to option #2.
I know financially speaking Option 1 would be the way to go, but I have to believe that paying option 2 is the best honestly. Here are my reasons:
1. You’ll pay it off the fastest give you that ‘win’ under your belt.
2. With the 2nd mortgage paid off, you can snowball that money into the first mortgage giving it a much faster schedule, AND if you ran into serious financial troubles (which I highly doubt) like maybe a serious medical problem or car and medical or who know, you’ll at least have that mortgage paid off and the cash stream available if necessary.
It’s a tough choice, but good luck!
I’d try refinancing the first again J. If you qualify, you can get it down to 4.5%. I’m right now in the process of refinancing as rates have gone down by at least 0.375%. Go for it!
Work on the 1st mortgage and shift to 2nd as rates shift.
80% towards Mortgage #1, 20% towards Mortgage #2. I know you want to go all in, but sometime you gotta suck it up and be safe .
Without a doubt, clean off the second mortgage. Get rid of that and bear down on the first. No question about it.
I think you should pay 80% towards Mortgage #2, and 20% towards Mortgage #1. That will you’ll be attacking mortgage 2 and hopefully still have it paid off (or at least mostly there) before the rate goes up, while still putting a decent dent in the first mortgage.
How much extra can you pay per month? That may change my idea. How much must you pay per month? Is there a cap for the variable HELOC?
I’m in the exact same situation right now and I am going with option number 2. Even though it has the lower interest rate there is no guarantee that it will stay that way in the future. I want it out of the way for the feeling of getting rid of it as well as lowering the risk of dealing with a higher interest rate later.
You ought to do what’s best for your wallet. Isn’t that what planning our financial lives is all about? So suck it up and start paying down #1! In two years, if interest rates start to rise, then you can reevaluate. (You’ll still have plenty of mortgage left to pay at that point — ha!)
Or, if you want to work on both, set up a plan where you pay of 10% of the #1, and then 10% of #2, and alternate. You’ll spend more time paying off the #1 sections, but you’ll still get a little rush from paying off chunks of #2 (or reverse it so you feel the thrill first, and then you can buckle down and work on paying off 10% of #1, which is costing you so much more.)
Right now we’re 100% focused on our second mortgage, but that’s because our math is easier to figure: #1 has about $310,000 at 5.675%, and #2 has $27,000 at 6.875%. I would love to refinance, but we’re probably 80 to 100 grand underwater. Blub blub!
Pay off loan #1
If you need to “feel” better and pay off the smaller loan first, I don’t think you are ready to pay off your debt. Yes it can take a long time, but is saving money more important to you or having Dave Ramsey hold your hand? Do the damn math larger debt/higher interest rate = less money for other things.
I would refinance the first mortgage to a fifteen year. Then with anything extra hit your second mortgage. This way you will be paying off both a little faster. We just went from a thirty to fifteen and with an extra $300 a month should have it paid off in ten yrs.
But first you REALLY REALLY REALLY need to read Dave Ramsey’s Total Money Makeover book – I think this debate is a sign that you are ready for his “teachings” and his wisdom:)
Seriously though you could knock out that second mortgage quickly and then put ALL your extra money towards the big mortgage and take big chunks out of it. You are competitive and disciplined enought to wipe that #2 out quickly!
Plus saying you have two mortgages is def. not sexy…..sooner you get rid of #2 the better.
I’m in the same boat. Is your second mortgage with Chase also? Ours is. I called about locking in a rate–they quoted me 9-10%! So I’ll keep my interest only loan going right now and try and pay it off before the term expires and I have to refi at the higher rate.
Why is this even a question? Obviously, #1 is the answer. As several others have stated above, the first mortgage has a higher interest rate AND a higher balance, therefore you are paying a ton of interest on it. Pay that puppy down. If the variable rate all of a sudden exceeds the fixed rate, then you can switch strategies. It’s not like you’re locking yourself in here.
I’d pay off the 2nd mortgage ASAP. Of course the psychological win is good, and the fear of the unknown (rates raising) is would be eliminated, but those are secondary for me. Only having the one mortgage means you have a better cash flow position, and if your financial situation changes, you will feel less of a pinch. Also, should you find yourself REALLY hard up due to extreme circumstances, you only have one creditor to deal with and don’t have to worry about a 2nd lien holder on your house holding up it’s sale.
Whenever I have questions I just save up cash.. If in 6 months it looks like 2.8% is here to stay then I’d throw my money at #1. If the 2.8% starts creeping up, you can always dump a lump sum into it.
Of course I’d leave the cash in some sort of CD to earn as much interest as possible on it while it sits there. Most likely, after 6 months I’d see myself paying off your 1st mortgage since the interest is higher.. With the gov. promising to keep rates low for the next two years your variable rate should stay very low for at least that long.
This shouldn’t even be a discussion.
Pay the high interest rate. If/when the other one starts going up (which certainly won’t be in the next year or two), then refinance it to a reasonable fixed rate. Done and done.
Since right now the 1st mortgage has the highest interest rate, I would start there. Then, if the rate on the 2nd one goes higher than the 1st I would switch to that one. You never really know what’s going to happen with adjustable rates (scary $hit by the way) until it happens. That’s just what I’d do. ;-)
I’d concentrate on the second mortgage for the reasons you mentioned. You can be done with it much more quickly, thus it will be eliminated from the equation.
You don’t need Dave Ramsey, I personally think that people follow him are fools – watch the Suze Orman show! Go with Option #1! WIN THE WAR FASTER, not some small battle! The interest rate on number 2 will stay low for a few years, when it goes up to 5% then put more money towards the second, until then you’re about being debt free as fast as possible, following the Dave Ramsey method will NOT help you reach this goal.
If you could pay them both off within the next 5-7 years, I’d do option 1 since you’ll have them both paid off before I think the variable interest on your 2nd mortgage will even matter. If you will be paying them off in 8 years or more, I’d go with option 2 since I do fear the unknown, lol. Either way, woot for debt payoff! Good luck!
#2!!!! Go for the ‘small’ win. At least you’d have one out of the way, feel accomplished, and then be able to focus all extra money on the other mortgage.
Pay off the variable interest rate one first.
I’ll be a bit of a devil here and not directly answer the question. A few weeks ago on Get Rich Slowly I saw a comment that stuck with me. It went something to the effect of, “you aren’t mitigating risk by paying DOWN a mortgage, you mitigate risk by paying OFF a mortgage”. The example used was, “the bank has to foreclose (for whatever circumstance) on two identical houses. Both are now worth 100k. One has a loan on it with 125k remaining, because the house has gone down in value since the bubble burst. The other house has a loan of 60k remaining because the owner had diligently been paying extra. Which house do you think the bank is going to put the most effort into going after? Obviously, the one where it stands to make the most money. The one with 60k remaining.” (If I can find the comment that I’m mangling I’ll post a link to it.)
So, I vote for putting a LITTLE extra to the payments (200 ish? 300?) but saving all the money someplace where you can pay the smaller loan off in one lump sum once you have it. Then I’d probably evaluate my e-fund before hammering the primary loan. If I had 1-2 years worth of mortgage payments saved I’d put all the extra toward the loan, and if I didn’t I’d probably do a 50/50 split (extra on loan to savings) until I did. That 300k will take a bit and I think it’ll be easy to get discouraged, not to mention that you don’t know what will happen while you are paying it off.
If you keep enough money liquid it will cost you an extra bit in interest (lets say 3-5k at worst), but you’ll have that money liquid if you want to, say, invest in the next Google. You also have it liquid if the market goes up a bit and you need to sell (or do repairs before selling). The interest rate on the 2nd mortgage will stay put for a bit, so I think it’s worth hanging on to the cash in case of issues.
Also, I think it would be AWESOME to be able to kill a debt like that in one fell swoop. LOL.
Found it. Here’s the link: http://www.getrichslowly.org/blog/2011/06/17/ask-the-readers-pay-off-the-mortgage-or-keep-the-money-in-savings/comment-page-2/#comments and it’s comment #72 from Troy. He is actually in the business, so I found it pretty interesting.
Do you have to pay PMI? If so, pay which ever mortgage that will get rid of the PMI.
I would pay #1 first because the fed said they’ll keep the rate low until 2013. That’s 2 more years with no changes on your variable rate mortgage. In 2 years, you can evaluate again. I don’t think the rate will shoot up that quickly.
Or (another thought!) you could save that money and try a lump-sum recast which would lower your note and give you better cashflow (depending on how important that is).
Anyway, can you tell I’ve been thinking about this a lot? :D Similar boat here.
Good luck and update us on what you decide. Thanks.
If you focus on paying the mortgage with 5.5% off first, depending on the extra amount you put in, you can get the interest saved on mortgage 1 to be almost equal with the mortgage #2 balance. That would look like the second mortgage is paid off by itself just from the interests saved on mortgage #1.
I personally would go with Option 1, but if you are leaning towards Option 2 I would try to figure out how much money you will be losing in interest by not paying down the 1st mortgage first. I think that might change your mind. The snowball method is for people who do not have financial sense and need the small wins to stay motivated. You are obviously not one of those people, so go for the smarter option.
I’d vote for paying off the variable rate. The whole reason you are doing this is for psychological reasons (aka it is driving you crazy). Knowing that you don’t have any variable rate debt will make it easier to sleep at night, especially given the current economic and political volatility.
My husband and I were facing the exact same scenario last year with student loans: lower rate, smaller total amount variable loan vs higher rate, bigger total fixed loan. Student loans are based off of the prime rate, so I researched what that has been historically and discovered that it has been in the upper 20s! Gulp! I knew financially it might not be the *best* decision (and we could only know that in retrospect), but getting rid of that thing was what helped me sleep at night.
Now that both loans are paid off, I haven’t gone back to crunch the numbers to see which would have made more financial sense. I probably won’t because I don’t care. It was the right choice for us.
Best of luck in your decision!
If you’re going for the “win” and the mental check off your list go for paying #2 off first. However, if you want to get rid of the 2 mortgages for financial peace so to speak, it makes much more sense to pay down the higher balance/higher iterest one first. The savings you get on paying the low rate/low balance loan will not equate to the extra interest you will end of paying on the higher rate/balance in the end. Throw all your extra at the higher balance/higher rate mortgage unless (or until) your other loan’s rate spikes. If it doesnt go higher than 5.5% stick to paying off the first one. Just my opinion :)
If you have more than a 1 bedroom. rent the extra one out. use those funds to pay off the variable rate mortgage. then contribute all your income (from working, not renting) to the main 5.5% mortgage.
You definitely need to pay off number 2 first.
It’s not a mortgage, it’s a HELOC and it’s variable. #1 is a fixed payment, you can’t get screwed with it if rates start going up. If rates are still low when #2 is done, withdraw a chunk of the equity again (don’t max it out) to pay towards #1, then continue paying down #2 again.
This also allows some flexibility for those unexpected moments over the next few years (J$ Jr. ??) if the payback scheme needs to slow down.
I’d pay off the second mortgage for a few reasons. One, is that you can always take money off the HELOC again later if you need to. So let’s say you pay off the HELOC and then decide “shoot, I wish I had paid off the 1st mortgage instead” then just go get money off the HELOC and send it to the other mortgage. Or you can use it for anything you need, hopefully you don’t need it but still… it’s nice to have the option. Paying off the HELOC first gives you more flexibility and security.
Second, I don’t know the terms of your HELOC obviously, but mine has a 10 year draw and then a 15 year payoff. Which means that once it’s been open for 10 years I can no longer draw from it and it switches to an installment loan. So then I have no choice but to make regular payments on the balance and it has to be paid off over the course of 15 years. Does that make sense? So if you are putting all your extra cash to your 1st mortgage you might end up getting stuck with huge payments on your HELOC.
I’m with Melissa, you should pay off the higher rate 1st mortgage first because of the higher interest rate. If interest rates were to triple over the next 5 years and it took you 10 years to pay off both of the mortgages you’d still break even.
In the meantime, with interest rates where they are you’re saving double the amount of interest by paying the 1st mortgage.
As far as the debt snowball is concerned. I think you might be happier with the win of saving more interest over the win of making only 1 payment a month.
OK so everyone has been say 1 or 2 without asking for more info. In order to make this decision there are a more factors involved. Your HELOC is variable, so it must follow an index or some sort of gauge, What does it follow? How is that index doing over the last 5 years? Any news on it’s forecast? Another factor is your adjustment cycle. Does it adjust every year or month? Third is your adjustment cap. There is a cap for your rate for the HELOC for the adjustment cycle and life of the loan. It could be it adjusts every year, can jump 2%, and maxes out at 10%. I don’t think they can triple your rate immediately.
I have a 7/1 ARM for one of my rentals. The 7 is the fixed term of 1st 7 years @ 5.125%. Then it becomes variable and adjusts to a new rate once every year. My 7 years just endend and my new rate is now 3% for the next year. The 3% is calculated with the balance of my loan at the time of adjustment. The interested for this loan is capped at 10.75%, so it will never go over that. The interest rate can also not jump more than 2.5% per year. So my next years interest rate would be 5.5% if the inex it follows go up, which is unlikely. Since the FED is not planning on moving the rates up, it not likely that your variable rate will triple.
In addition, if you have 25% equity in your home, you might able able to refi your 1st mortgage down to 4.125% for 30 years or 3.375% for 15 years, which will free up a bunch of cash every month. Then you can figure out what you want to do with that cash.
I feel like it would make most sense to focus on the first mortgage, but re-evaluated every 6 months to a year to see if the variable rate is creeping up on the fixed. If the 2nd mortgage rate surpasses the first one, then switch gears. It’s a little less set-and-forget, but I feel like that’s the best way to go!
No doubt in my mind, option #1. I see Dave Ramsey has been mentioned and his advice for how to pay off debt is not fiscally sound. The amount of the debt has no relevance here at all. Paying off smaller debts first so you feel better is just a smoke screen for fiscal ignorance. In the end you want to spend as little money as possible to pay off these debts. Concentrate on the highest interest rate first, bottom line. The variable rate does throw a wrench in it, but rates aren’t going up any time soon, and when they do it is unlikely they’ll surpass 5.5% that quickly. You can always change your strategy down the line, but take the bird in hand, not the two in the bush.
This is no different than if these were credit card bills or any other bill with an attached interest rate. I would pay off the one with the higher interest rate first, then work my way down to the next highest, etc. It’s true that the 2nd mortgage has a variable interest rate, and that it could change at any time (the Fed’s promise on consistent interest rates notwithstanding). But in order for the 2.5% rate to increase above the 5.5% rate, it would have to nearly double. And it’s not going to do that for quite some time. Bottom line, I always focus on the higher interest rate balance first. It will pay off in the end.
I would focus on the second. What if you run into some financial difficulty in 5 years and want to use the extra cash for food or something? You could always cut back to one payment if you had the second knocked out of the way. But if you were focused on the first mortgage, you wouldn’t have it paid yet and would still have 2 payments to make. Think about the impact of cash flow and having the flexibility if you need it.
Using the info given… Extra payments should go towards the first mortgage. My reasoning:
1. It has a higher interest rate
2. It has a higher balance so you’ll be paying more interest longer at a higher rate.
3. According to your net worth update, you have nearly $60k in cash sitting around (EF+cash savings) – if something horrible happened, financially you’ll be okay OR (the other concern) if interest rates rise dramatically (which at the very least isn’t going to happen quickly) you could almost pay the entire second mortgage off.
In my opinion, you don’t have to worry much. You have excellent savings and the variable rate isn’t a huge concern. Pay down the higher interest debt, why pay your mortgage holder any more interest than you have to?
I agree with those saying go with option 1. The reason Dave Ramsay says to start with smallest debts first is for the psychological factor of not getting discouraged when nothing is getting paid off. I don’t see you having that issue, at least not at this point in your life.
Plus, as others and yourself have pointed out, the rate on that HELOC isn’t going anywhere anytime soon. And if it does suddenly triple overnight, then it’s rate is still only a little more than what your conventional mortgate rate is at, and then you would switch gears to pay off the HELOC.
Id have to agree id hammer on the 1st mortgage, you got 2 years at minimum to bang down the higher IOU, which your paying significantly more interest on. forget about the “win” and work on the interest, even if your interest went up to 5 on the 2nd mortgage after 2-3 years your still not paying nearly as much interest.
work on paying off the first mortgage until the 2nd inches up over the first in interest rates.
I like a mix of Option 1 and Option 3 … here’s exactly what I’d do:
Step 1: Keep an extra-fat emergency fund.
Step 2: Option 1 (pay off the higher interest loan)
Step 3: If your variable-rate mortgage shoots above 5%, you’ve got the extra-fat emergency fund to cover your minimum monthly payments, and at this point you can start paying off the variable-rate mortgage.
Lots of really well thought out replies here. I’m in the pay off the highest rate loan first camp, which ever that one is at the time. You did not specify, but I imagine that both loans require some minimum monthly payment, so you will of course be paying on both loans each month.So what I would do is to pay the minimum monthly amount required on the lowest rate loan, and pay the maximum that i could manage ( after maxing out the eligible retirement/ health saving plans ) on the current highest rate loan.
I would pay off the HELOC because of the same reason Erin provided earlier in regards to the tax break. No matter what you do the situation is tough. At least you know what to expect from the 1st mortgage. Can you knock out 61k in 2 years just in case interest rates do go up? Again, props to you for not walking away from your house, I would have ran…
I would focus on #1 until mortgage #2’s interest rate is higher.
I also tend to add 10% to my minimum payments so that i feel like I’m actually make some sort of progress towards it. Then whatever is left goes to the account with the highest interest rate!
Lots of good points…I would be tempted to pay off the 2nd one so I could ‘see’ something getting paid off. However, the financially smarter way would be paying off the first one. I’m sure you knew that :)
Here is a thought though…to help with the physiological brain that wants to ‘see’ results – create a visual chart – three of them actually. One for each loan to see how much it is going down over time and then make the third one a pot of how much ‘ extra’ you have thrown into the mortgage. Seeing that pot grow will let you see how much has gone into it. It could be depressing on one hand if you see how much ‘extra’ money is going in that direction but if you remind yourself that is funds to pay down your debt, it could be rewarding to see that.
I am pretty conservative with my money, so my first instinct is to say pay off #2, as I like predictability more than greater earnings. However, if you can keep other assest sufficiently liquid that you could pay off #2 as a lump sum if intrest rates started to climb, then paying off number #1 would make the most sense. I think you need to look at your assets as a whole, if your assests are not earning sufficient passive income, then you might want to liquidate them to pay off your mortgages.
I’d probably do the second mortgage for many of the reasons described above. Peace of mind is sexy.
Another question. Can you refi the 5.5% loan into a 15 year? My 15 year is 3.75%
1. Housing values will recover. They always have. Every single time.
2. Consider the opportunity cost of paying off your mortgage (either one) early, instead of socking that ‘extra’ money away in liquid investments (by ‘liquid’ I don’t mean beer and mojitos but rather things that can be turned into cash quickly). If rates adjust up, you might still be better off with more cash on hand that with a slightly lower principal. higher interest rates are a double edged sword. your mortgage will go up but so will the interest you could earn on U.S. Treasurys.
3. That said, I would be more inclined to try to convert the ARM to a fixed, pay the minimum mortgage and build a mighty contingency fund.
If you are concerned about inflation, consider plopping some cabbages into the Vanguard TIPS fund:
no one can predict the future but $10k put into this fund in 2001 would be almost $20k today. low risk, fairly predictable rewards.
Plan B: You could just sell the house and buy a tour bus. Go full-on Rock Star!
WOW. First off – THANK YOU so much for taking the time and sharing your opinions with us! That really REALLY means a lot, no joke. I even got emails and PHONE CALLS from some of you wanting to help! Hah! You’re honestly the best readers ever, I can’t thank you enough :)
Here’s the total votes so far on which to do:
*****PAY 1st mortgage first: 33-ish
*****PAY 2nd mortgage first: 16
*****Refinance again!: 5? (not an option… yet)
*****Sell your house: 2 (I’d love to!! Esecially one of your ideas on jumping in an RV and doing a Rockstar tour ;) Who wants to convince my wife??)
And here are some responses:
(I wish I could respond to all y’all, but that would take like 3 hours :()
@Melissa – That’s an interesting way of looking at it! Small wins by chunking it up, good idea :)
@Henry, Nicole – That is true, I am motivated no matter which route I take – good point.
@Kyle – HAH! I would love that more than anything right now good sir. Just not ready to take the $60k-$80k hit yet as my house is way under water ;)
@tom – I’ve never read Predictably Irrational, but I’ve heard of it. Regardless though, if something feels better whether it’s rational or not, it still feels better ;) There’s a lot of things we do that doesn’t make sense, but at the end of the day we’re pretty happy about it.
@Walnut – Already on it! Thanks man. (oh, and yeah 30 year fix and 15 year HELOC)
@Sarah Fowler – Nah, just refinanced 3 months ago and that was the best I could get. I’m too underwater to qualify for a lot I think, though it’s always an option in a few years maybe? Especially once I get this game plan in action :)
@Erin – Yup, we can still write off 2nd mortgage interest :)
@JOB’s Money Free by 30 – I like the way you think!
@Financial Samurai – HAH! Again in 3 months? and pay all the fees again? No thanks. But honestly I wouldn’t qualify anyways :( Glad you do though!
@Ginger – I’ll get to all that in my game plan ;) But yeah, there’s a cap on my HELOC, though I haven’t looked at it in a while so not sure what that looks like.
@Chris – Interesting… and so far so good, yea?
@Alexis – In a wierd f’d up way, I wish our 2nd was way higher than our 1st – just so that it would be 100% clear cut. Wanna trade? ;)
@LB – You’re forgetting that if I lose patience/get bored, then I’m liable to just stop paying it so hardcore like that – which is what I’m trying to avoid going into this major overhaul. Is that stupid? Possibly. Weak? Probably. But we all have to act on our own personal traits or we lose focus. Not saying you’re wrong – just that there’s no “1 way fits all” answer to these guys.
@matt – Nice! love that plan – well done!!
@Den – Haha, I don’t know about that much. I like my credit, and Dave would have none of it ;) But yeah – I def. hear ya on the pros to paying off the 2nd one first.
@jennypenny – Nope – USAA has our 2nd. And lock-in is around 5-6% ;) 10% is crazy talk!!
@Supadad33 – It’s a question because that route doesn’t excite me as much ;) And we all know that if we lose interest, we start veering off our paths… but I can say hearing some of this stuff over and over again is def. helping, so thanks!
@engin33r – That’s been my position for the past 4 years :) But eventually I have to own up and do something about these last remaining debts, so that’s why I’m turning the tide and focusing all my extra money in that department. I’m still a HUGE fan of hoarding cash until the right decision though!
@Kevin @ Thousandaire.com – Done and Done only if it keeps my interest ;) No pun intended.
@Ash – HAH! Me too :) And honestly, I’ve been hoarding cash like a mad man the past few years to get all my ducks in a row when I took the leap of going the full-time blogger route. Which is GREAT and awesome, and all kinds of safety feeling, but now that I have all that part set, it’s just time for me to start getting rid of some. The responsible way at least, haha… but dude – THANK YOU for taking so much time in responding so thoughtfully! That is awesome. I appreciate it more than you know and you better believe I’ll consider everything :)
@retirebyforty – Nope, no PMI :)
@GJ – Hah! I like that thinking – “I probably won’t because I don’t care. It was the right choice for us.” – I hope I’m that confident once I make up my mind! (though it’s not the worst thing in the world if I change it mid-way through, of course).
@anon – I would LOVE that!! Best idea yet, haha… You’d have to concince my wife though ;)
@Ashley @ Money Talks – Yup! It does make sense :) Only we’re so underwater that if I pay it all off completely it’s gone for good… our house isn’t worth that anymore, *sigh*
@LLF – Nope, we’re underwater by $60k-$80k :( We got lucky in refi’ing 3 months ago… but I agree, it is harder to have an answer w/ *all* the details for sure. Thanks for taking the time to comment!
@Mark – “Paying off smaller debts first so you feel better is just a smoke screen for fiscal ignorance.” Well, I’ll have to disagree with you on that one – esp if you consciously make the choice based on your own preferences – BUT, yes, financially speaking only it’s the wrong move. But there’s alway more variables than just 1 with this stuff ;)
@StackingCash – Oh man, that would be absolutely LAST thing I’d do! I strongly believe in owning up to your promises and agreements, and crazy varibles excluded, it usually pisses me off when people walk away just ‘cuz it’s not a “good deal” anymore… though I wouldn’t hate YOU for doing it cuz I like you, but I’d def. try and convince you otherwise ;)
@Kari – That’s an idea! I’ll think about it :)
@Mike – Nah, no refinancing for me for quite some time. Too underwater, and not willig to spend the fees again after just doing so 3 months ago… but in 3-5 years it’s a totally diff. situation – especially once my plan is in effect! :)
@WR – If you could convince my wife, I would TOTALLY go on tour in an RV!!! Honestly, home ownership is not for me – I’m ready to unload it as soon as the timing is right.
I say #2. That way when the house value goes back up and you want to sell you’ll be out from under the HELOC.
I just may go that route! Stay tuned :)
I know I’m late to the party, but I just want to say that I’d go with route number 2. It offers less reward but less risk. Let’s say you pay $80,000 into your first mortgage and something god-awful happens, like your business plummeting or being injured in a way that renders you incapable of working… You’re still going to have the same bills you did, only now you can’t refinance your first mortgage because you don’t have income. That same $80,000 used to first pay off the HELOC, then start toward the mortgage and you have one less bill to worry about in the same worst case scenario. That risk mitigation is worth the difference to me. I’d imagine that especially being self-employed with variable income, trying to free up monthly cash flow could be extremely helpful if you ever deal with lean times.
Ack! What are you trying to do, scare me?? :) Haha… but yeah, good point. Just another variable to add into the mix!
Just a thought – and maybe it doesn’t work like this in the US, but in NZ you can only pay a small percent over the minimum payment on fixed mortgages. Therefore, if I were you, I would either go with option 2, or, with option 3. Maybe I would be swayed towards option 3 even though you don’t like it, because you could set the payments at the max they will take on the first mortgage and then challenge yourself to find more money to get the second mortgage paid off in a certain amount of time. And maybe you won’t notice you are spliting the extra payments after a while because you can set and forget the payment on the first mortgage.
nope, no cap on %’s here when paying off the mortgage :) well, at least with ours – some people have pre-payment clauses and penalties, which may make it bad for certain options indeed.
I’m late as well, but just wanted to give my two cents.
I vote for Options #2. I’m all about small “wins” most of the time. I say pay off the HELOC first because if you DO decide you want to sell your house, not only do you have to worry about getting enough money for it to cover your mortgage balance, but also enough to pay off the HELOC. What if it’s not enough? Then you can’t sell it or you have to come up with another way to pay off the HELOC.
The HELOC is just sitting there, maxed out and you can’t use it at this point. I say pay it off first. At least if something happens (like if your wife loses her job, you have a baby, need to move, your self-employment goes into the tank) the HELOC is one less bill you have to worry about.
Or do something like this, pay 80% of your HELOC off, then focus on the mortgage. At least get the HELOC down to a comfortable balance where if something happened to your income, you could still make payments.
To me, the HELOC has more risk and could hurt you in the long run. Pay that sucker off, or at least DOWN.
Please let us know what you decide!
Haha, will do my new friend! I’m getting there ;) Thanks so much for your input.
We are in a similar situation. We have a 15 yr, 1st of $175k at 4.75% and a variable 2nd at $75k, currently at 2.25%. There are 7 yrs remaining on the 1st. We accelerate paying off the 1st and hope to pay it off in 4 years and we make the required monthly payment for the 2nd.
Since your 1st is a 30 year Mtg, you should concentrate on accelerating your 1st.
1. The interest is much higher on the 1st – huge savings.
2. Not sure how old you are, but if you are 40, do you want to be paying a mortgage when you
are in your late 60’s. You cannot buy back time.
3. The Fed raised rates incrementally, often .25 per quarter. If they raise rates by this amount,
for 11 straight quarters (2 years and 9 months), only then will your 2nd equal the rate of
4. While your 2nd is not paid off, your HELOC will remain open. If something catastrophic
happens, you will have access to funds, to cover the unsuspected expenses. You can even
use the HELOC to pay the 1st, to buy time if you become unemployed. You cannot do that
with the 1st.
5. Motivation – When you see that your 30 yr mortgage will be paid off in 5, 10 or 15 years, you
If the Bernanke continues to print money (QE3, QE4, etc.), eventually we will enter a period of hyperinflation. Rates will climb faster, the dollar will be worth less, and you and everyone else will be in deep doodoo. See Weimar Republic or Zimbabwe. A hedge for this would be to own some gold. Calculate how many ounces of gold it would take, to buy your house in 1970 ($35/ounce) and how many ounces it would take to buy it, now ($1,700+/ounce).
Disclaimer: My post is not meant as a recommendation, and should be used for entertainment purposes only.
haha, nice disclaimer ;) but yeah, def. see the pros here for sure. Though our HELOC is maxed out, and by your theory if we had it paid down that would mean that all $60k was open to be used if need be. With it maxed it can’t, so as it stands can’t take any money out of it ;) but really, we’re over $60k underwater so it doesn’t matter — either way we don’t have access to it, haha…
and not 40 yet! by then my goal is not to have ANY mortgages anymore – which I’ll be blogging about soon ;) appreciate the feedback!
This question can not be answered simply without know all the facts, such as:
size of retirement savings account and what type of accounts (tax free- Roth or 401k – IRA)
All these things figure in to first whether you should be paying down your mortgage or not and which one you should be paying down first.
Personally, I’ll be retiring in 6 months and I still have plenty of mortgage, but the other side of the equation is entirely full (that is why I say your net worth matters – it is not merely the money or lack of it in one particular side of the equation). So if need be I could pay the mortgage off tomorrow, but at 3%, I can think of better things (and places to go) to do with it.
One factor that I always suggest is that you never get more equity in a single asset like your home than you have in your retirement account — because who knows when some “hurricane” is going to rumble through your neighborhood and leave you with nothing.
Agreed! I prefer to have more cash/money in investments than “equity” anyways… our net worth is $270 w/out house/mortgage, $220 WITH it ;) (and I’m in my early 30s)
Anyone who has a positive net worth prior to age 30 is doing ok, so I say as long as you are putting 15% towards your retirement, then the rest should go towards the higher rate 1st mortgage, at least for now. The fed seems content on keeping interest rates down for the next couple years – though there certainly is no guarantee, but because the 1st is much larger than the second, it would be my preference to work it down, or if you plan to stay in the house for more than 5 years then you could try to refi.
Word. Appreciate your thoughts.
Am I alone in thinking that “buy fat burning furnace” could benefit from READING your blog? I for one AM a fat burning furnace, and sure don’t need to buy one. LOL.
I am in the exact situation you are in, except my 1st is $150k, 4.75% fixed and my 2nd is $65k at 2.25% (prime – 1%).
I put much more emphasis is on the 1st, because of the higher rate. There were no emotions involved in making my decision. It was based solely on the figures. The prime rate, would have to go to 5.75%, for my 2nd to equal my 1st. That is an increase of 2.50%. That increase would not happen over night. If rates start to trend higher, I will have plenty of time to change my emphasis to accelerating the 2nd. Keep an eye on the 10 year notes.
@Yana – I think “buy fat burning furnace” was a big spammer, and is no longer on this thread ;)
@To Lee – Yeah, I think your way is def. more solid in terms of actual finances and facts, I just would have never started on paying off *any* of it had we not gone w/ the 2nd mortgage first. Which is pretty crazy coming from a big money nerd like myself, but I’m starting to know myself pretty damn well over the years ;) And now here we are, 6 months after Operation Pay Off Mortgage has been in effect, and we’ve already knocked away $12,000! I really hope we can keep it up cuz having *any* of that debt just really sucks, haha… hope you guys continue to do well too.
To help with our goal setting, we determined that every additional $10k, accelerates our payoff by about 5-6 months. It depends on how far along you are on your mortgage.
We also refinanced 8 years ago to a 15 year Mtg. We did not want to be making a Mtg. payment in our later years. Amazing how much interest you save, vs a 30 year Mtg.
This year, we will pay an additional $25k, and reduce our payoff date by about a year
I wish you the best in your quest to be debt free.
Love it! 15 years are totally the way to go for sure – or even paying it off as if you had one even if technically you have a 30 year like we do ;) The more that’s paid off now, the less it all builds up! You’re in an excellent position indeed over there :)
I am a math teacher and I have researched this for a long time. I went to my college professor from 20 years ago. I talked to him 6 monhts ago (spring 2012) i showed him a chart I made. It was a curve, a growth curve. a curve that at first grows rapidly and as you move along it grows less and less until it levels to zero. Imagine grabbing the population growth curve and flipping it. Note that in population is the other way around. at first it grows slowly and later ti grows rapidly.
My point here is that this growth curve compares the amount extra you put each month to how long you finish paying the mortgage.
Example: a 350,000 mortage at 5% with monthly payment of $2100
(here I am just making up some numbers)
Put zero extra a month savings on interest 0
put 300 extra a month total savings on interest 40,000 Difference 40,000
put 600 extra a month total savings on interest 77,000 Difference 37,000
put 900 extra a month total savings on interest 111,000 Difference 34,000
put 1200 extra a month total savings on interest 140,000 Difference 29,000
What you can see is that the first few hundred shave off the most amount on your mortgage interest and you would be a fool if you dont put at least 100, 200, 300, 400 extra a month.
as you put more and more each month the benefit decreases to a point that even if you put 4,000 a month!!!! it will not decrease the loan by much.
Same thing happens with the number of years you finish paying early.
The first few hundreds shave off the most months (years form the loan.
But If you put way too much like 4,000 a month. it will really only shave off just a few months.
the question is what is the BEST amount ( in math the point of maximizing the money we put in the loan)
You will have to crank the numbers for your scenerio and each time you mark the amount of money and time you saved. then you will see the point where the graph has like a hump (where is changes from negative to positive) That is your best amount to put each month in the mortgage.
So You must to a combination of the two.
Never stop putting a few hundred in to you loan. (did you know that in a 5% 350,000 dollar loan the difference between a 30 year and a 15 year loan is about (maximum) 700 a month.
Some people think that to lower the years in half from 30 to 15 you have to double the payment from 2100 to 4200. NO! That is amazing!! just a few hundred dollars will lower a great amount of time and interest paid.
So dont stop putting (In your case) about 500 a month in to the first, the rest you can get dump it in the Second.
when you are done paying the second, then snowball the amount on the first.
i was thinking that you can mayve put that number that helps you shave off years. The rest you can invest in a safe No load Index fund or something like that.
You know, I think you’re actually on to something there. I remember doing the calculations with “what ifs” going higher and higher, and it seems I got less and less impressed actually after hitting a certain point. Not that it would stop me from still going any faster or anything, but there WAS a point where it just wasn’t as exciting anymore…
Great great comment, thanks for sharing my man! :)
Pay down the highest rate first. No, it’s not fun or sexy, and no, you may not get quicker satisfaction from doing so, but finances is ALL ABOUT numbers, not feelings. Assuming you are going to be putting money toward something every month for paying down debt, it MUST go towards the debt with the highest rate. Anything else is literally a waste of money. As adults, we need to get past the idea that the emotional bump you get from eliminating one payment is worth any money at all. People need to be smarter about money, not focusing on how it can give them warm fuzzies. Detach emotionally from money, and the answer is clear. It also is necessary if you are ever going to have a rational relationship with money.
hah! it’s funny reading this now after all these years and how my own mindset has changed :) and it’s pretty much the opposite of yours in that I actually *harness* my emotions now as I’ve found it propels me much faster than looking at the cold hard numbers… But that’s the beauty of personal finances eh? we all have our own methods that work? while some are better off ignoring their emotions – and i’ll agree here that it’s probably the majority vs the minority – there’s still validity in using your emotions to your advantage too… I would never be in the position as I am now having ignored them.
I have a similar but different dilemma.
I Have a Mortgage Loan and a maxed out HELOC.
Interest rates are only a .025% different. (HELOC is higher)
Balance on loans are only $2,000 apart.
so not too much difference in balance or interest rate.
Mortgage payment is $700 per month
HELOC payment is $200
I have enough to pay off one of them right now. Which one should I pay.
the HELOC with a little higher rate.
or the Mortgage which will reduce my debt to income ratio?
I am planning on building/buying a house in about 2 years.
A nice “problem” to have – congrats! :)
I’m not sure what the right answer is for you, but it seems that in either case you’d be sitting pretty. And maybe another option is to hold onto all the cash to be used towards the new home coming up too? Or do you already have enough there and are just amazing with money??? :)
I had the same (almost) 1st and 2nd mortgage amounts as you. My research informed me it’s just better to go to your 2nd mortgage banker and negotiate term and rates for the future on the 2nd. I did that, and was able to negotiate a fair deal in writing. I then paid off my first, and was left with a lot less monthly payment, about $3,000/month. My 2nd is now in primary position, but that’s why you figure out what you need and negotiate with 2nd before you pay off the 1st mortgage. Plus, it’s always good to have the 2nd mortgage money put away for a rainy day in case the mortgage bank (either one of them) turns south on you. Never trust a mortgage banker is my advice.
Haha, indeed on that one… I went back to renting a few years after posting this and love not having to mess with any of it again :) Though once we settle back down I’ll prob be jumping back into the ownership game.