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I did an 80/20 financing for a home I bought for $280K that is currently worth about $210K, yet I owe a total of about $265K right now. My primary is 6.75% and 2nd is 8.6%.

I have also have a $7K car loan at 7%. I do not have any unsecured debts except a student loan at 3.375%.

Does it make any sense to pay down on principal for the 2nd loan since it has the highest interest rate, or is it a lost cause because of being underwater? I only have about $3K in savings, so I would be out of money real quick if I lost my job.

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  • I've added the info from the comment you've left, please check if it is correct. Jul 13 '11 at 9:26
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I'd split whatever cash flow you have between saving money and paying down the 20% loan.

The fact that you are carrying an unrealized loss isn't really too relevant -- unless you have plans to walk away from the loan or go bankrupt, it doesn't really matter until you sell. You're either going to repay now or later.

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  • I am very concerned about the possibility of losing my job in the next few years because of cuts in government spending which directly impacts my line of work, or the possibility that I might give up waiting for appreciation to allow me to sell the place in the next few years.
    – Bob
    Jul 13 '11 at 1:11
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You're welcome to throw in the towel and stop paying any time you want. You'll just suffer the consequences of doing so.

It sounds like you're concerned about losing your job "in the next few years." What are you doing to stem this off? Are you building up a side income? Are you building up portable skills -- ones that can be used anywhere? If you think you have a few years left, use them. Build something up. You may be able to recover more quickly, or last longer until you find a new job.

Some of my blogging friends have been at it about as long as I have, and they're in high-five, low-six figures now. For blogging. Some did it even faster. All it takes is time. Your expenses for starting a blog are $10/month plus cutting out two hours of TV / drinking / anything else consumer-ish to learn more about your favorite interest, write about it, and interact with the online community.

That's just one idea. Season to taste or choose a different meal altogether.

Are you frugal? Are you looking for ways to cut expenses? If you can find extra money to save a little bit more and knock out just one of those debts (say, the car), you'll be able to throw that payment at the student loan. Then they'll both be gone, and you can save up a cushion for yourself faster.

I just think it's a little weak to give up when you're not really in trouble yet. You're tight, but you can get through that.

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If you're planning to walk away from the house - don't invest any more money in it. Just be aware of the consequences. It may be worth considering a short sale if both the lenders will agree to erase the debt.

If you're going to keep the house, then the fact that you're underwater now is irrelevant, and you should do your best to reduce the burden by paying off the higher rate loan. But, I personally think that accumulating enough cash to make you comfortable in case of a job loss for several months is a higher priority.

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  • 1
    I don't plan to walk away from the house, but I would like to sell is as soon as possible, but realistically I'm thinking that won't even be a possibility for a couple of years.
    – Bob
    Jul 13 '11 at 1:09
  • @Bob - you can only sell it in a short-sale, because you can't make up the difference between the market price and the debt secured by the house. The lenders won't let you close the sale without a short-sale approval. Start working on it, it has impact on your credit, and will require a great deal of negotiations with the lenders. If you're going to keep the house for two years - you can hope for the market to rebound, which I doubt is going to happen, but you have to have a cash cushion to fall on in case of an emergency.
    – littleadv
    Jul 13 '11 at 1:12
  • I'm mainly torn because I don't plan to walk away, but I'm worried I will spend money on paying down and then lose the house in the next few years because I lose my job or something.
    – Bob
    Jul 13 '11 at 1:16
  • 1
    @Bob - that's a valid concern, that's why I would put savings to be a priority before reducing the loan principle.
    – littleadv
    Jul 13 '11 at 1:17
  • Agreed with savings, or paying off car loan. Jul 13 '11 at 19:53
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I think everyone else answered before you added the info about your car loan in your comment.

While it makes sense to pay off loans with the highest interest rate first, keep in mind that in most cases you can deduct mortgage interest from your taxable income. So the after-tax rate of interest that you're paying on your 8.6% second mortgage will be less than your 7% car loan, assuming that your tax bracket is more than 18% (federal and state combined).

If you plan to use your funds to pay down debt, definitely attack the car loan first.

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Well, I suppose it depends on your idea of a "lost cause".

Are you planning to lose the house to foreclosure? If so, then yes, it's a lost cause. Don't waste your money paying down the principal.

In any other scenario* you should absolutely pay down the principal to the extent that you'd pay down any loan with nearly 9% interest (in other words, moderately aggressively).

The fact is, you owe someone $265,000 unless you plan on losing the home to foreclosure. You can manage the amount of interest you pay while you hold that debt by paying it down.

* Short sale and bankruptcy would be special conditions as well, but not exactly the same effect as foreclosure.

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  • I also owe $7K in a car payment at 7%. Does it make sense to pay this down over the 2nd mortgage?
    – Bob
    Jul 13 '11 at 1:12
  • Since you can likely deduct the mortgage loan interest from your taxable income, I would definitely pay down the car loan first. Jul 13 '11 at 9:24
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There are programs out there which will let you refinance even when underwater, under the Government's HARP program. You are overpaying by nearly $7,000 per year compared to a refinance to 4.5%. A classic example of how the bubble hurt people who overextended themselves a bit as housing shot up.

The bank risks a $50K loss if you default or short sell this property. I'd go in and sit down with a branch manager and ask what they can do to recast the loan to a lower rate as you are ready, wiling and able to keep the house and make your payments. Good luck.

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