Underwater, should I pay off second mortgage?

[carlVA]

I'm in my early 30's and I originally bought my home in 2004 for 298K. I took out a primary and secondary mortgage for 80% and 20%. The first loan was a 5/1 ARM which is now at 3.25%. The second loan was fixed at 8% for 30 years. Since then the value of the house has dropped to ~230K and I owe 52K on the second mortgage (213K on the first). I have 80K in a "high yield" savings account and I am thinking about paying off the second mortgage. I'd have 28K left which would leave with a healthy 6+ month emergency fund.

I'm not sure if it is a good decision because:

1. I'm paying 52K but will only have 17K in home equity.
2. I'd like to buy another house within the next 5 years. Removing money from savings will reduce the amount I can afford for a down payment on the next home if I were to rent my current one.

The plus side:

1. Paying off the 8% mortgage will net me a lot more than keeping it in a savings account.
2. I'll redirect the money I was paying on the mortgage to save up for another house. I estimate that I could have another 50K saved in ~3 years.

Alternatively I could move the money from a savings account to bonds which should yield more than the savings account but I'm worried about what will happen to the bond values when rates start to rise again.

Thanks, Carl

[jIM_Ohio]

You will owe the 298k whether you stay there or move, so I suggest paying off the second, then rebuilding savings.

Once you do that, I would consider locking in rate on a fixed for the first... if you plan to move in 5 years, you might change your mind, and rates are not going to get lower.

[maat55]

IMO, moving to bonds is an risk(I would rather chance gold or silver if I were going to gamble). I would be happy with paying off the 8% debt and keep saving in a safe vehicle.

But, I would not rule out that the housing market has not reached bottom yet.

[greenskeeper]

A lot could happen in 5 years. I would probably continue to pay the monthly amount due. You are only "underwater" on paper until you try to sell. You could always take your lump sum and pay down the mortgage when you are ready to sell.

If you were going to sell within the next 6 months you almost have to pay down the mortgage.

I hope that things will be better in 5 years, but it is looking more and more less likely.

[jIM_Ohio]

A lot could happen in 5 years. I would probably continue to pay the monthly amount due. You are only "underwater" on paper until you try to sell. You could always take your lump sum and pay down the mortgage when you are ready to sell.

If you were going to sell within the next 6 months you almost have to pay down the mortgage.

I hope that things will be better in 5 years, but it is looking more and more less likely.

some of this is good logic-

regardless of house value, regardless of whether OP sells now or in 5 years or in 10 years, the OP owes on the second mortgage, and it's costing him 8% now. OP can lock in that 8% return by paying it off now... better to have savings earn you 1% than to have a debt cost you 8%. That is a 9% spread, and even "if" house appreciates, it will probably not be able to cover that spread.

The debt will be there until its paid off... and while debt is there it costs OP 8%.

[JoshuaHeckathorn]

Since you believe you have an adequate EF, I would pay off the 2nd too. Save the 8%, and start funneling your cash away again to save for the new house.