05 S60 AWD 2.5T Automatic Transmission Trouble and Bevel Gear Noise

[JuanAmigo]

I bought a 2005 Volvo S60 AWD 2.5T about 7 months ago with 110K miles and it has developed some incredibly awful problems recently. About 3 months ago the check engine light came on after I noticed a little bit of hard shifting and error codes P0811 and P0700 appeared. They are both clutch and transmission related, so I took it into a Volvo specialist mechanic and he said there was a definite noise (like a whooshing or grinding) noise coming from the transfer case and that the transmission fluid was overfilled and black.

He suggested that I buy another car and that I was facing a possible transmission replacement and transfer case replacement. Wasn't an option for me at that time.

I ended up draining the transmission fluid and replacing it myself, and the car drove a bit better for a short while. Didn't see any metal shavings in the drained fluid. A month later, I noticed that the gears would shift erratically especially in stop and go traffic and that the acceleration and power were both fading. This is noticeable driving up hills, as the car will shift back and forth between 3rd, 4th and 5th gear to get the power to climb. The transfer case noise has gotten worse, so I'm thinking of buying a used transfer case and getting that swapped out.

Does a bad transfer case make a transmission worse and cause loss of power and acceleration? Does this seem to be just a TCM issue?

Considering scrapping this terrible purchase if transfer case replacement doesn't help these issues.