Paying Off Mortgage With Inheritance

Lisa writes in with the following question regarding mortgages and inheritance:

My father-in-law passed away recently, and we would like to pay off our 2nd mortgage with some of the inheritance money that we will be receiving. We have been in our home for 15 years and took out the 2nd mortgage in 2006. While the thought of reducing our debt and increasing our monthly savings is our first priority, my husband and I are not sure how this will affect our taxes next year. Also, we were planning to move sometime within the next 2 years after our daughter graduates from high school. How will this affect the price that we sell our home for?

Lisa, first of all, I’m sorry to hear of your father-in-law’s recent passing. I know this is a difficult time for both you and your husband. And what a blessing it was to receive an inheritance.

As you know, I’m not a big fan of mortgages (they are a necessary evil for most of us), and I like second mortgages even less! That said, it may or may not be the best time for your to clear that mortgage depending on the shape of the remainder of your family’s finances.

First, if you do not have an adequate emergency fund, I would park some of this money in an online savings account to cover several months of household expenses. If you have already established a solid emergency fund, I would use some of the remaining money to clear high-interest, non-deductible debt such as credit cards and high-interest loans.

With your emergency fund in place, and debt free except the house (and the second mortgage), it is time to evaluate the second mortgage. I like Dave Ramsey‘s rule here: if the second mortgage exceeds half your annual income, I would simply include it as “house debt” and pay it down on schedule (or a little early as income allows). If the amount of your second is less than half your annual income, use inheritance funds to clear as much as possible.

If you were deducting interest on the second mortgage at tax time this will affect taxes. However, I’ve never understood the argument to send a mortgage company $10,000 a year in payments to save $3,000 a year on taxes (rough example). My personal rant aside, if you have questions about the tax implications it might make sense to talk with a tax professional to determine what the bottom line impact of paying off the second mortgage would be.

As for selling the home in a couple years, by paying off the second mortgage you’ll increase the likelihood that you will get some equity out of the sale. Paying off mortgage debt also gives you more wiggle room when setting the sale price of your home. If the house was fully leveraged, you would be less likely to be in a position to reduce the price for a quick sale.

Whatever you decide, my best advice is to move slowly. When we lose family members emotions are raw, and rarely do we make sound financial decisions when emotions are driving us to make them. There’s nothing wrong with parking the money in a money market account, or CD, for a few months while you think over how best to use the inheritance. You only get one opportunity to use this inheritance wisely, so make it the blessing it was intended to be.

Ask the Readers:  What advice do you have for Lisa and her husband?

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