Save cash or pay off second mortgage?

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Dear Dr. Don,
I currently have a home financed with a 5/1 adjustable-rate mortgage. The first mortgage is for $179,000 at 5.75 percent interest, and the second is a $38,000 adjustable-rate loan. I have the cash to pay off the second mortgage of $38,000. Should I do that or put it into savings?

— Mark Mortgages

Dear Mark,
There’s a simple answer to this one: Look at the interest rates.

If the effective after-tax interest rate on your second mortgage is greater than the after-tax rate of return on your investments, then it makes sense to pay down the mortgage from savings.

By the way, why aren’t you looking to refinance? You have more than $200,000 in debt, with most of that debt currently at 5.75 percent. That’s extremely high right now. According to Bankrate, people with good credit can refinance into a new, 30-year fixed-rate mortgage at 3.52 percent. They can get a new, 15-year fixed-rate mortgage at 2.86 percent and a new, 5/1 ARM at 2.74 percent.

It makes sense to refinance now, unless you expect to sell the home soon. Refinancing also is tough if you have a poor credit history. And it can be difficult if you don’t have any equity on your home, though you may be able to finesse that issue using a Federal Housing Administration mortgage. If you’re eligible, the federal government’s Home Affordable Refinance Program, or HARP, is an option.

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