Pay Down Mortgage? (insurance, loans, interest rate, 401k)

[grandcentraluk]

Looking for some advice. I currently own a home that appraised for $25,000 under what I owe. Add to it all the associated costs of selling the home and you have over $40,000 that I would have to bring to closing.

I elected not to sell the home and hope to rent it out. If not, it can stay vacant for awhile as I own another home and can manage the mortgage, insurance and taxes on this home.

My question is, what should I do about this mortgage? Home prices in my neighborhood are going to stay low because foreclosures and short sales have become the new norm. My instinct is to take some of my money and pay down a chunk of the mortgage so that when I do sell, I don't have to bring that much to close. I figure this will save me on interest as well. However, I am not really financially savvy and someone told me that it makes no sense to pay down a bad mortgage and that I should just save my money and let it earn interest in the bank. I've also been told that I should've sold it and brought the $40,000+ to close.

Does it make sense to pay down the mortgage? Does doing so reduce my principal at all? Is there any benefit to doing this?

[Lacerta]

The only reasons not to pay down the mortgage, in my opinion, are
1. If you are not financially capable of doing so
2. If you can make more on the money somewhere else
3. If you get a good tax writeoff on it.

It sounds like #1 isn't a problem for you. Since it isn't a primary residence, I would guess #3 is a no. And I have to laugh at "earning interest at the bank". If your bank pays more in interest than the interest rate on your mortgage, I will move my money there yesterday.

So, are you financially capable of paying down the mortgage without putting other things in jeopardy? Do you have money in other forms of investing? If so, are they making more money than the interest on the mortgage?

Most of the time, people say to pay down your mortgage if you already have a 6 month (or more) emergency savings, if you have no other debt, and if you are already maxing your other retirement options (IRA, 401K, etc)

*Edit* If you are financially capable of keeping up on the house and don't intend to do a short sale or give the house back, the above is my advice. If you think there is a chance you might give the house back to the bank or sell short someday, my advice might be different, but if you have assets, and don't intend to file bankruptcy, you'll likely have to deal with the shortage even if you do give it back.

[VictorBurek]

I would say hold onto your cash. Keep the money in your account where it will earn you compounding interest. Why pay down the mortgage now when you can hold that money and bring it later if you have too. Plus, what if something bad happens to the economy or with your job. I would much rather have cash.

[acegolfer]

Since you said you are not financially savvy, I'll simplify it for you.

Suppose you are given 3 investment choices.

A. 15-yr CD at 5.5% *
B. 1-yr CD at 1.5%
C. risky assets such as stocks with unknown return but most likely earn higher than 5.5% in the long term.

Where would you invest? There's no correct answer because it depends on each personal situation.

If you say A, then pay down mortgage. If B or C, then do not. It's simple as that. If you don't know the answer, then you really need to think about it.


*(If you want more realistic numbers, for A, replace 15 years with the minimum between the remaining life of the mortgage and the number of years till you expect to sell the house. And replace 5.5% with your current mortgage rate.)

[aneftp]

My advice since I was in a similar situation you were 2 years ago: (assuming you are financially secure).

If you want to rent it out (which sounds like you are), than by all means save that 25-40K you have instead of paying down the mortgage.

If you plan on selling at a lost, use that money at closing.

But like others have stated, don't go half way (pay down mortgage while renting it out) cause many things can happen during rental like your tenants not paying etc. You are much better off saving that money.

[grandcentraluk]

Thanks to all the responders. Acegolfer, thanks for breaking it all down for me, it made far more sense once I read your post.

I think I am going to keep my money and wait and see what happens. I was inclined to pay it down as I have taken care of all other financial obligations (no debt other than student loans locked in at a low rate, maxed out 401k and IRA) but since I don't see myself ever selling this out for anything other than a loss (I imagine it will take YEARS for home prices in the area to go back up), I might as well keep the money and bring it to close in the future.

Aneftp, if you don't mind telling me (and feel free to PM me if you prefer), how did everything work out with your situation? I hope to sell the home someday as I have a very demanding job and do not have time to be a landlord (will be using a property manager). I just need to get to a point where I don't have to put $40k down to sell the home. I would love to hear from someone who went through this - most people I know have not been in a position to qualify to purchase two homes so I feel like I don't have any examples to draw from.

[aneftp]

Originally Posted by grandcentraluk

Aneftp, if you don't mind telling me (and feel free to PM me if you prefer), how did everything work out with your situation? I hope to sell the home someday as I have a very demanding job and do not have time to be a landlord (will be using a property manager). I just need to get to a point where I don't have to put $40k down to sell the home. I would love to hear from someone who went through this - most people I know have not been in a position to qualify to purchase two homes so I feel like I don't have any examples to draw from.

I purchased a new home in Florida in early 2009. So I was carrying two mortgages. I live way below my means, so carrying two mortgages occupied less than 20% of my monthly income. I had a lot of room to wiggle.

So here was my situation:

I decided to rent out my home in 2008 (my home was in the Maryland Suburbs which were pretty immune to the housing crash; the ghetto areas or super far off suburbs had already suffered the most housing declines but not the very good locations). My home was still worth around $600K (pretty much what I paid at peak in 2005, my next door neighbor had just sold an identical home in August 2008 for $610K). I was "busy professional" just like you. Had a new job offer down in Florida. Had very good tenants so I wasn't concerned.

Than Lehman Brother's hit...BAM. The whole economy tanked, even the highly resistant Washington DC area. Than my tenants lost their jobs. They had to move out. But I was already losing close to $1000 a month by renting it out plus I can't write off any passive rental income since my income is greater than $150K. I was living in Florida and didn't want to be a long distance landlord. I had very good tenants. It was practically a brand new home they were living in and they took care of it but I wasn't going to tempt fate again by renting out, especially since I was losing money each month.

By me deciding not to sell in 2008, I basically cost myself over $100K. That's how fast the real estate market is moving. Including real estate commission and closing costs (I gave the buyers a $10K closing credit), I had to wire $37K at closing. I have the money (that's what emergency savings are for but still stings a lot). Ending up selling for $500K plus the $37K closing costs. A lot of money to lose very quickly. My entire downpayment plus my principal payments I was making.

Moral of the story: If you are planning rent, it's got to be for at least 3 years. If you are upside now, you will still be upside down 3 years down the road.

My advice: If you have the cash and want to unload it, do it now and price it aggressively. I ran the numbers myself. It costs me around $3700 a month to maintain my property up in Maryland. I can afford the payments easily but just do the math. If I just let the property sit empty for 6 months, that's $22K in mortgage payments. If it lingers for 12 months, that's $44K. Plus I get hit with the AMT (alt. min. tax where you lose your property tax deductions). So I bit the bullet, was under contract in under 30 days and closed in 60 days. I undercut my competition by more than $25K in price.

So fast forward to 2010. I still look at the listings in my old neighborhood. My competition from way back last year is now a distressed property, and he's listing as a short sale for $65K less than what I sold for just last July 2009. So the real estate market is still moving in the wrong direction in my old neighborhood (mainly newer homes built at the peak of the bubble 2005-2007). I had one of the cheaper homes to began with. Those homes went from $500K up to 1.5 million. According my old real estate agent back in Maryland , there was only 1 foreclosure and 0 short sales in 2009. Now there are 5 short sales and 2 foreclosures so it's like a domino effect for the worse. So if I would have continued to rent it out for another year, I would have been out another $65K.

So the moral is if you are planning to rent it out, it's got to be a longer term solution. Prices (when/if) they hit bottom, will stay flat for a long time.

But if you only plan to rent it out for a year or two, you are only delaying the inevitable. So it depends on your cash flow situation.

Here's another tidbit. By me freeing up another $3700 cash each month, I put some of that money back in the stock market. May a nifty $60k capital gains in the past 8 months.

So you might take a $40K hit right away by selling the place, but you will make up that difference very quickly investing it somewhere else. Assuming you are successful person, you will have setbacks in life, but you will recover much quicker than those who are so financially strapped.

[GeorgiaTransplant]

I've honestly never understood keeping a house "for the tax advantage".

It always seemed to me you're paying a bunch of interest to get *part* of that interest you paid back in lower taxes. Why not pay off the mortgage, and now you don't get charged interest in the first place?

$10,000 -> out to interest

$3,000 <- in from lower taxes

= $7,000 out (negative)

How about, instead,

$0 -> out to interest

$0 <- in from lower taxes

= $0 out

Love for someone to maybe explain to me why that makes sense in simple terms...that aren't just 'it's a tax deduction, so it's good!' Any takers?

[aneftp]

Originally Posted by GeorgiaTransplant

I've honestly never understood keeping a house "for the tax advantage".

It always seemed to me you're paying a bunch of interest to get *part* of that interest you paid back in lower taxes. Why not pay off the mortgage, and now you don't get charged interest in the first place?

$10,000 -> out to interest

$3,000 <- in from lower taxes

= $7,000 out (negative)

How about, instead,

$0 -> out to interest

$0 <- in from lower taxes

= $0 out

Love for someone to maybe explain to me why that makes sense in simple terms...that aren't just 'it's a tax deduction, so it's good!' Any takers?

This is the way most financial savvy people view the benefits of mortgage interest tax deductions for home.

You have to compare the rents vs. mortgage payments in your area.

Say the average rents in my old neighborhood ranged from $3000-4000. What does it cost to buy a home and it's average mortgage payment? So here's a simple way to look at it.

I will break it down.

1. My mortgage interest payments were about $2200 a month. (that's a $700 tax savings each month).
2. Property taxes were $600 a month (that's another $200 in tax savings assuming you don't get hit with the AMT).
3.Home insurance (about $60 a month, no tax savings).
4. Principal payment (about $700 a month).
5. HOA ($200 a month), includes community pool and gym

So during the boom many people never bothered to make principal payments (either with negative amortization loans or interest only loans).

So if you use my case above. If I elected to go the interest only route (I didnt', but let's assume I went with the interest only route).
My average monthly mortgage payments would have been about $3000 a month. When you factor in the "tax savings" of almost $1000 a month, it's really only costing me about $2000 a month to live in a home I otherwise would have paid at least $3000 to rent.

That's how you play the mortgage interest deduction/property tax game.

That's why so many people never bothered to pay into the principal each month cause they felt their homes would have appreciated in value. So while I was paying $700 into the principal each month, people "saved that $700 and spent it on cars, vacation etc".

[Momma_bear]

Originally Posted by grandcentraluk

Thanks to all the responders. Acegolfer, thanks for breaking it all down for me, it made far more sense once I read your post.

I think I am going to keep my money and wait and see what happens. I was inclined to pay it down as I have taken care of all other financial obligations (no debt other than student loans locked in at a low rate, maxed out 401k and IRA) but since I don't see myself ever selling this out for anything other than a loss (I imagine it will take YEARS for home prices in the area to go back up), I might as well keep the money and bring it to close in the future.

Aneftp, if you don't mind telling me (and feel free to PM me if you prefer), how did everything work out with your situation? I hope to sell the home someday as I have a very demanding job and do not have time to be a landlord (will be using a property manager). I just need to get to a point where I don't have to put $40k down to sell the home. I would love to hear from someone who went through this - most people I know have not been in a position to qualify to purchase two homes so I feel like I don't have any examples to draw from.

In the late 1980s we purchased a condo in CT and found ourselves underwater by about $20K on a property that we purchased for $120K with a 20% down payment (this current downturn is not the first and probably won't be the last). Rents at the time were HIGH so it made sense for us to stay there and pay the mortgage because our monthly mortgage less tax benefits was less than renting another apartment. So we stayed for 6 years.

Since rents were high at the time we turned the property into a rental. We lost money on a monthly basis, but it wasn't a huge loss and we wanted to buy a house since we had one baby at that time and were planning more.

When we applied for a mortgage on the house we had to list the existing mortgage on our condo and submitted a copy of the lease to the bank with our mortgage application. They included 75% of the rental income and 100% of the mortgage debt during the underwriting process. Since our income had grown substantially over the prior 6 years we qualified for a mortgage and continued to rent the property. I don't think we made any money on the rental although at some point we did break even on a cash flow basis.

After 12 years of owning that unit we decided to sell it (we moved to FL and it was to difficult to manage from far away). We sold it for only slightly less than what we owed on the mortgage. It did take us 12 years but we were able to get out from under it without having it destroy our credit, or eat up huge amounts of our cash.