What is the Best Way to Pay Off My Modified Mortgage?

Question:

Dear Steve,

I bought my house in 2006, right before the first recession. In the midst of the chaos, I got a lawyer to get a loan modification, which allowed for annual increases to my APR. It went from 2% to 5.125% loan in 5 years. I currently owe a total of $255,640. The principal loan is now $175,149 at 5.125% interest. The 2nd principal is $80,491, an 0% interest rate. I have 188 payments left before the loan expires in 09/2036.

My question is, what is the smartest way to pay off my house without incurring additional interest charges on the 80k interest-free portion of the loan. My idea is to pay $6000 a year towards the loan portion with the interest rate.

I believe at this rate; the loan will be paid off in 12 years. Then I would pay the same amount to the interest-free portion of the loan for the remaining 3 years.

Will this save me money? Or should I pay the $6000 a year into the 0% interest loan so it will be paid off in time? It almost looks like it does not matter which option I pick with the math I am doing. Please give me your expert advice.

Edward

Answer:

Dear Edward,

I’m happy to give you some feedback and things to think about to make the best decision for you. Ultimately there is seldom one definitive answer because decisions are made by a fluid combination of emotion and math.

Thank you for including the PDF with the snapshot of the loan information.

I sure wish I could find my crystal ball to tell you exactly what interest rates would be in the future. The only interest rates that can be guaranteed are the current rates.

It is actually possible to refinance a first mortgage if the second mortgage holder agrees. And since it appears to be with the same lender, then it could be easier to do in your situation. Refinancing the first into a low rate new loan could significantly reduce the overall interest you would pay.

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It might be worth talking to the bank and asking about reducing the interest rate and the payment on the first. If you went with a 30-year fixed mortgage, you could always increase your monthly payment as able.

From my perspective, the quandary is if it makes more sense to dispose of the interest charging mortgage by increasing the payments. Mathematically that makes sense. But it would not make sense if you have an inadequate savings account or not maximizing your retirement savings.

For example, putting that extra money into an employer-sponsored retirement account that matches your contributions would go further and historically return more than paying down the mortgage.

That is where the dilemma comes in. If you ramp up payments to the mortgage now but miss out on the value of time-magnified investments, then, in the long run, you lose having a bigger retirement account to depend on.

I noticed that the statement you sent says the loan started in August 2006 and was a 32-year term, but the loan ends in September of 20236. Somewhere we are missing two years. This might be an anomaly caused by the modification, but it is odd.

It is also unclear if you are paying anything into escrow from your current $1,762.47 monthly payment.

If you were making payments towards the interest-bearing mortgage, it would take $1,357 a month for 188 months to pay it off.

I’m sorry I have more questions than answers at this point. We need to unwrap the current mystery before we can plan a path forward.

So here is some homework for you. You can post the answers and updates in the comments section of this question, and I will see them.

  1. What was your second mortgage balance a year ago? Is it the same or reducing?
  2. Are you paying anything towards escrow each month?
  3. What did your lender say about refinancing the first mortgage? Did they give you many options when you asked?
  4. Are you participating in an employer-sponsored retirement plan that matches funds you deposit? If yes, are you maxing that out?
  5. Do you feel you have an adequate emergency savings account balance available if you ran into a large financial emergency?
  6. Are you planning to remain in your current home for the next 15 years?
  7. How old are you now?
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Sincerly,
Steve

You are not alone. I'm here to help. There is no need to suffer in silence. We can get through this. Tomorrow can be better than today. Don't give up.


Damon Day - Pro Debt Coach

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