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Here's the story:

  1. Paid off Mortgage #1 for House #1
  2. Bought House #2 with Mortgage #2 (30 year fixed at pretty good rate)
  3. Sold House #1 after about 4 months of paying down Mortgage #2.

My question is what to do with the proceeds from the sale of House #1?

Invest? Pay down Mortgage #2 (about 1/3)? Bury it?

I've heard that the bank may agree to a "one time adjustment" to lower the payments on Mortgage #2 because of paying a very large payment. Is this something that really happens?

Is a large payment early in the amortization schedule a bad thing?

Update

There is no other debt besides Mortgage #2.

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    The same thing you would do if the money came from any other sources. Pay down high-interest-rate debt. Use it to support increasing your 401k or IRA investment percentage. Invest the remainder as per your long-term investing plans. – keshlam Sep 27 '16 at 18:03
  • @keshlam Indeed - the source of money has no bearing on where it would be best suited. – Grade 'Eh' Bacon Sep 27 '16 at 18:10
  • Agree about the source of the money (it doesn't matter). See my update. There is no other debt. There is no high-interest debt. – Ronnie Overby Sep 27 '16 at 18:23
  • The term you are looking for is called a recast or re-amoritization. If you apply a large sum of money against your principle then you can get your monthly payments recalculated for the remainder of your loan instead of the usual shortening the length of your loan. My mortgage broker offers unlimited recasting for a fee of $250 per recast. No, a large payment is not a bad thing unless it puts you in a bad financial situation. Weigh your options and figure out the costs; that's all there is to it. – MonkeyZeus Sep 28 '16 at 19:26
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I've heard that the bank may agree to a "one time adjustment" to lower the payments on Mortgage #2 because of paying a very large payment. Is this something that really happens?

It's to the banks advantage to reduce the payments in that situation. If they were willing to loan you money previously, they should still be willing. If they keep the payments the same, then you'll pay off the loan faster. Just playing with a spreadsheet, paying off a third of the mortgage amount would eliminate the back half of the payments or reduces payments by around two fifths (leaving off any escrow or insurance).

If you can afford the payments, I'd lean towards leaving them at the current level and paying off the loan early. But you know your circumstances better than we do.

If you are underfunded elsewhere, shore things up. Fully fund your 401k and IRA. Fill out your emergency fund. Buy that new appliance that you don't quite need yet but will soon. If you are paying PMI, you should reduce the principal down to the point where you no longer have to do so. That's usually more than 20% equity (or less than an 80% loan).

There is an argument for investing the remainder in securities (stocks and bonds). If you itemize, you can deduct the interest on your mortgage. And then you can deduct other things, like local and state taxes. If you're getting a higher return from securities than you'd pay on the mortgage, it can be a good investment. Five or ten years from now, when your interest drops closer to the itemization threshold, you can cash out and pay off more of the mortgage than you could now.

The problem is that this might not be the best time for that. The Buffett Indicator is currently higher than it was before the 2007-9 market crash. That suggests that stocks aren't the best place for a medium term investment right now.

I'd pay down the mortgage. You know the return on that. No matter what happens with the market, it will save you on interest. I'd keep the payments where they are now unless they are straining your budget unduly. Pay off your thirty year mortgage in fifteen years.

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Really this is no different from any kind of large lump sum and having a mortgage. There are probably many questions and answers on this subject. It really doesn't matter that the proceeds were the result of a sale, an inheritance would not change the answer.

I think it is important to note that the proceeds will not eliminate the house 2 mortgage.

A high level choice of investment one makes is between equity (such as stock) and debt investments (such as bonds and mortgages). You are in a unique case of being able to invest in your own mortgage with no investment fee. This may tip the scales in favor of paying down the mortgage.

It is difficult to answer in your specific case as we don't know the rest of your finances. Do you have a sizable 401K that is heavily invested in stocks? Do you have the need for a college fund? Do you have an emergency fund? Do you have a desire to own several homes generating income property?

If it was me I'd do the following in order, skipping steps I may have already completed:

  1. Establish an emergency fund
  2. Contribute some amount to retirement. Perhaps max my ROTH if I had not already done so this year, and maybe next.
  3. Establish a college fund for my kids. The younger they are the easier this is to do.
  4. Pay down the house.

I've heard that the bank may agree to a "one time adjustment" to lower the payments on Mortgage #2 because of paying a very large payment. Is this something that really happens?

I really kind of hate this attitude. Your goal is to get rid of the mortgage in a timely manner. Doing such makes paying for kids college a snap, reduces the income one might need in retirement, basically eliminates the need for life insurance, and gives one a whole lot of money to have fun with.

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