Changing Gears on Our Debt Repayment
For the last 3 years, we’ve been on a mission to pay off our non-home debt. In that time, we’ve paid off about $82,000! You can track our current status in the debt scales in the sidebar.
But now we’ve decided to switch from paying down our car and school debt to paying down our second mortgage.
If you recall, we financed our home purchase with two loans. Since we didn’t have nearly enough for a down payment (even 5%), we got two loans. The first, for about $311,000, was 80% of the total price of the house, while the remaining 20% was about $78,000.
The Loans in More Detail
So not only did we finance 100%, but we also got a 5-year, interest-only mortgage for loan #1 (the big one). That means by late 2009, we’ll need to either sell the house, refinance the loan(s) or just let the rate reset to the current market rates.
Yeah, we were dumb and couldn’t afford what we bought at the time. But we lucked out and we can now easily afford the mortgages. Whew!
The makeup of the loans are as follows:
Loan 1: 5/1 Interest-Only Arm, $311,000, 5.250%
Loan 2: 15 year balloon loan (amortized over 30 yrs), $78,000, 7.875%
Why Change Our Plans?
Compared to our starting point on non-home debt of $112,000, we’re so close to being rid of it all with just $30,000 left to pay off. So why not finish what we started?
Well, we’ve recently found out how much home prices have fallen based on talking to our neighbors and looking at home sale reports for the area. In another year, in order to refinance both of our loans together (to reduce the interest rate on the 20% loan), we would need our home appraised at $470,000. That’s the 20% equity above the total loan amount that the bank needs to finance the full loan.
At the last appraisal, our home was valued at $470k. Unfortunately, that was about 3.5 years ago, before everything went down the drain. Right now, based on research, I expect it would be appraised at $420,000. Granted, it might not sell for that, or it might, but we would need to give concessions at the closing table, but I’m confident it’s still there.
So with that assumption (and hope), to get our loan fully-financed, we would need to get our total loans from $389,000 down to $336,000. Wow. That’s a $53,000 reduction in the loans.
Our New Debt Repayment Plan
So since our second mortgage is the higher interest rate of the two loans, and of all our debt, even after the tax deduction for interest paid, our plan is to pay down the 2nd mortgage first. I doubt we can pay down the full $53,000 in the next 14 months, but we can get a good chunk of that out of the way. The other hope is that real estate values start increasing by that time and a new appraisal would come in closer to $440,000.
If all else fails and we can’t get both loans refinanced together, then we’ll just refinance the first loan (the one that is resetting) and continue to pay down the second loan. It just doesn’t make sense to skip the mortgage debt that has the highest overall interest rate simply because it’s “good debt” as some people say.
Debt is debt, even if it’s supposedly an appreciable asset (that is currently depreciating) that has tax benefits. If you’re paying more interest on it (even after taxes) than your other debt, then you need to pay it off first.
For us, though, it’s been easier to pay down the smaller $10,000-$30,000 debts because an almost $80,000 loan seems just too overwhelming to handle in comparison. But as I said, debt is debt and we need to make the logical decision right now, not the emotional one.