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Funny you should mention that!
I've just experienced the exact same problem on my '89 740. It's absolutely no fun driving on a cold, rainy day with a couple of inches of slush on the road, the windows fogged up, the heater off, a rag in one hand, the windows half down, and a pool of anti-freeze building up on the passenger floor tray. I was just this very minute starting to peruse the archives for hints on dealing with this when I stumbled over your post. Coincidence? I think not! The Volvo gods must be restless.
As for diagnosis, there is not much doubt you have a fluid leak in the cabin area and that means the heater core as there are no hoses (those nipples you see sticking out through the firewall are part of the heater core). Presumably you've either just had a rad flush or you've been ignoring your rad fluid change for too long (or both, in my case).
Most good anti-freeze fluids will have a certain degree of leak stoppage ability so if you've just changed fluids and it's only weeping it may "heal over", but don't get your hopes up. Although they might work well for a case like yours, I would be *very* hesitant to use any of the aftermarket stop-leak treatments (Bars being one of the more infamous). You might run the risk of plugging up or at least restricting your heater core or rad. Note that these magical fluids work when exposed to air and there can easily be pockets of air at the top of the cores. Perhaps others will differ on this, but the decision is yours.
As for dealing with this, I agree with Steve, it's going to be a tedious job and it sure wouldn't hurt to have Harry Potter -The Sorcerer's Illustrated Guide to Volvo Heater Replacement (aka. the Volvo green Heater Manual). A quick look at my Haynes manual (the 740 '82-'88 edition will do fine) revealed some of the basic steps and invaluable diagrams. Also, a quick look in my AllData CD gave only a few additional cryptic steps for replacement (very poor content on this as AllData is really only good for powertrain topics). If you don't go for the Volvo manual then at least get your hands on a Haynes (try your local library) and checkout chapters 2 (secs 21-23), 11 (secs 33-37) and 12 (secs 33, 35).
Here are the guidelines I've developed so far:
1. You're going to be working primarily from the left footwell (orient vehicle for good access and lighting)
2. Prepare yourself: Verify sufficient inventory of favourite brew. Brush up on four letter word vocabulary.
3. Loosen rad expansion tank cap then clamp off heater hoses and disconnect at firewall (old hoses can be a real pain to get off; nipples are delicate; be prepared to catch fluid when you succeed). To be able to drive the car without the heater, simply join the two hoses (a 1/2" i.d. copper pipe 90 deg coupler works well)
4. Disconnect battery as a precaution when working around dash accessories and the relay tray.
5. Remove ashtray (and holder), lighter (pull lighter plastic bezel straight out) and storage box (remove two screws and swing out at left).
6. Remove shifter console: Two screws under plastic clip in bottom of storage box. Remove plastic cover below brake handle and pry off metal clip at front of console (under ashtray area) to allow centre section of console to be spread and moved around shifter column. Disconnect seat heater switches and swing entire centre console back up out of the way.
7. Remove left under dash panel: Note Torx head screws. Disconnect and remove air duct under steering column.
8. Remove right under dash panel: Carefully work plastic covering around heater fan motor.
9. Remove glove box: Note two nuts on either side.
10. Remove radio: Flat retaining clips hold side edges. Remove knobs (pull/pry straight out). Clips should be visible behind outer edges. Insert hooked wire through knob openings (upward and outward). Grab clip and pull in slightly to release clip as you work console out. Remove radio compartment (held by screw in tab at upper rear).
11. Remove left and right console side panels: Remove side panel bolts (1 at lower front behind carpet, 2 at lower rear behind carpet, 2 at upper front inside console at radio slot area). Detach lower crossbar (pull both panels forward slightly to allow screwdriver access from rear; loosen screws; bar is slotted on both ends).
12. Remove heater control panel: Remove surround trim (carefully snap out trim with protected blade gently prying inward and outward; note the metal retaining clip holding the middle of the trim panel to the right of the electrical switches -release clip from behind dash by pushing toward switch; disconnect switches). Remove metal bracket below heater controls. Remove heater control panel and swing out of the way to the right.
13. Remove ducting: Remove right and left outside face vent ducts (behind glove box and behing instrument cluster over steering column). Remove centre panel vents (remove short duct then push out vents). Disconnect floor vent ducts (peel back carpet; remove tunnel duct screw; reef out plastic stud; pull back rear floor vent ducting and wiggle off floor distribution box outlets. Remove floor distribution box from under main distrbution box (release relay tray and swing out of the way to the left; remove relay tray frame; remove centre screw securing floor distribution box to main distribution box; remove floor distribution box sliding out to right side). Remove main defroster duct to allow access to upper distribution box cover screws (unfortunately this duct is secured with grip clips on plastic studs that will seemingly break off during any attempt at removal; in order to gain restricted access to the upper distribution box screws you can try just removing the foam collar from the base of the duct and working through that restricted gap).
14. Remove air distribution box cover: Remove the *12* screws securing the distribution box cover (including two in middle of top -a diagram really helps here). Separate the cover from the box by prying with a blade (putty knife) inserted into the mastic (starting at the lower right and prying up the right seam) allowing you to remove the cover by hand (don't be too forceful once you get it started in case you've missed a screw). Note the locations of the four coloured vacuum servo hoses connected to the cover then remove them (unclip the tab then slip off).
15. Remove heater core: simply held in by the two long side clips.
16. Mop up spilled anti-freeze: The tunnel carpeting, passenger footwell and left rear footwell are the prime target areas. Extract the excess from any soaked carpets (a carpet shampooer is ideal; a wet/dry vac is the next best; blotting with old towels will do; rinse and repeat). Peel up all wet carpet areas, blot up any excess including foam side of underpad). Leave carpet up until areas are dry. Dispose of liquid anti-freeze and contaminated rags properly.
17. Visit chiropractor
Total time for removal is somewhere in the 1-5 hour range.
Replacement heater cores are available from Volvo (p/n 1308374, for all 700/900) and on-line from places like ipdusa.com, AllOEMVolvo.com, carparts.com and global4auto.com. Brands are 4-Seasons (variously as p/n 94734 and p/n R3000-62353) and Everco (p/n H5121) with prices between U$100 and U$250. Used heater cores are probably not a very good buy when you consider you're paying the labour to have a used one removed and the labour you may soon have to repeat if it also fails.
Some of that I'm fairly familiar with and some of that I obviously don't yet fully comprehend or simply got wrong. In any case, many of these steps are non-trivial and worthy of their own procedure guide. I'll update the list when I'm done. In the meantime, perhaps others will make corrections and suggestions.
I reserve judgement as to whether this constitutes a bigger effort than a 240 heater fan motor (done that twice). So, with photocopies and a printout of this message in hand I will bid you adieu as I dive under the dash. If you don't hear from me then I may be in need of a rescue squad with the "jaws of life" and a back board or, more likely, one of those nice little sound-proof rooms with upholstered walls.
-Dave
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