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Question of the Day – Reader Question
By JLP | October 19, 2006
A good reader of this blog sent me the following email:
I’ve been reading your web page for a couple of months. I have a personal finance question that’s been running through my mind. Any chance of you posting it / answering it / opening it up for responses?
I have a fixed (6.150%) equity loan, current balance $73K and a HELOC (8.250%), current balance $15K. There are no prepayment penalties.
I make the mortgage payments each month and have about $1,000 extra each month that I’ve been splitting (not always evenly) between the 2 notes.
Which would be the best use of the extra $1000? Should I funnel that money towards the high interest HELOC? Or should I put that money towards the fixed equity loan’s principle and lower the overall payoff?
I’m currently contributing over 10% to my 401K and funding my grandson’s 529 plan. I’m comfortable with these deductions and want to use the extra cash for mortgage payments.
My response:
He doesn’t specify whether or not he has an emergency fund but since he says he has an extra $1,000 per month, I’m going to assume that he does. That said, I would pay off the HELOC first since it has the highest interest rate. If you apply the entire $1,000 to that loan, it should be paid off within a year. Then, once that is paid off, go for the mortgage if your goal is to be totally debt free.
Now, what are your thoughts?
Topics: Question of the Day | 14 Comments »
October 19th, 2006 at 11:42 am
Paying off the HELOC will also lower his monthly payment. Paying down the 1st mortgage will keep his payment the same although more will go to principle.
October 19th, 2006 at 11:45 am
I would recommend paying down the HELOC because it is at a higher rate, it is a variable rate and it will lower his monthly payment. In addition, with the HELOC his additional paydown payments are still accessible. If he needed the money for an emergency, the HELOC is still available.
If he pays down the 1st mortgage, that money is gone, it has been converted into equity that cannot be released without a refi.
October 19th, 2006 at 12:13 pm
I would go with paying off the HELOC myself. Then I’d think about whether you really want to pay the first mortgage down early vs. investing it somewhere else. As Ken says, once you pay it off, you can’t get it back out without a refi or a higher interest HELOC.
October 19th, 2006 at 12:27 pm
If he also has a car loan, pay toward that one first! Depending on the tax bracket, the effective interest rate on a 6% car loan can be higher than 8.25% HELOC.
October 19th, 2006 at 12:42 pm
Also, it’s good to pay down the HELOC since it’s likely variable-rate and already at a pretty high rate. The fixed-rate mortgage is probably OK as it is; even if he wants to pay it down, he should make sure he’s funding any other retirement vehicles (401K/Roth) and has a well-padded efund before going after it.
October 19th, 2006 at 12:57 pm
I don’t see the need for an emergency fund with an accessible line of credit. I would pay down the HELOC before any term note, car loan, or emergency fund, becaues the HELOC is liquid and can be reborrowed if necessary.
October 19th, 2006 at 2:57 pm
I’d pay off the HELOC first; there’s a higher interest on it and it’s the smaller of the two. Once you pay it off (about 15 months based on the info given) you can apply the extra $1000 plus whatever you were paying on the HELOC to the equity loan. Splitting them means you’re paying interest longer on both of them.
October 19th, 2006 at 3:44 pm
HELOC for all the reasons stated above, emphasis on the VARIABLE rate. Things seem to have flattened out a bit, but my Prime + 1 (or whatever) when I got it 3 years ago jumped to 6%, 7%, 8% seemingly over night. Actually, I paid it off before it got to 8%, but it was crazy what it did to my payment (interest only). Get rid of it, then only use it if you need it. Fixed is good, variable bad in today’s economy.
October 19th, 2006 at 4:26 pm
Hmmm…. I’d figure there would have been at least someone advising to put more money into the fixed mortgage. I can understand paying off the higher rate note early, then throwing more money at the other note. Does it make any sense whatsoever to pay off the fixed rate early? Wouldn’t more towards the principle cut down the total amount of money paid towards the fixed note? Just playing devil’s advocate…
October 19th, 2006 at 5:11 pm
Weary, I would like to have seen someone disagree with the group, but there just isn’t any justification. The HELOC carries the higher current rate, and the risk of the rate increasing in the future.
October 22nd, 2006 at 9:42 pm
[...] AllFinancialMatters, an in-real-life financial planner helps a reader decide how to deal with an extra $1,000. [...]
January 30th, 2008 at 9:54 am
“Which would be the best use of the extra $1000? Should I funnel that money towards the high interest HELOC? Or should I put that money towards the fixed equity loan’s principle and lower the overall payoff?”
Use the HELOC as an “interest cancellation account” and use it to accelerate the equity in your home. YOu’ll payoff your loan years sooner than you thought possible.
It’s not the interest rate of the HELOC that is important — rather it’s the amount of interest that your paying that is what you should pay attention to.
Today’s Real Estate market means that folks can no longer count on appreciation to build home equity. Those who realize that they need to pay down their current mortgage debt are looking for alternate ways to aggressively (yet safely) build equity.
And they’ve discovered a perfect online system to do that; they can focus on their wealth accumulation goals while accelerating their equity simply by using a Home Equity Line of Credit to ‘power’ the Money Merge Account™ financial solutions program.
A typical 30 year loan (of whatever type) can be paid down in 1/3 to 1/2 the time — it’s a great way to save *huge* amounts of income by eliminating a mortgage amortization front-end interest load. (On a million-plus dollar home, I’ve personally seen where the Money Merge Account™ program will save the homeowner $750,000 in interest charges!)
And the best thing – homeowners don’t have to refinance their existing mortgage or, in most cases, make any adjustments to their lifestyle.
It is unfortunate that most of us were never taught to follow three essential principles: (1) Avoid paying interest, whenever possible, (2) Use other people’s money, whenever possible and (3) Find and use a financial system that will guide you, especially if you have the tendency to go off-track. The Money Merge Account™ software and the program’s counselors use these principles to keep each homeowner focused on their wealth accumulation goals.
I’d be happy to provide further details…
February 1st, 2008 at 2:51 pm
tell his grandson to use the MMA with the money he will be getting so it saves him more money in the long run.
February 11th, 2009 at 9:53 pm
I’d agree, pay off the HELOC and then work on the mortgage. However, I would not keep the HELOC balance at zero. There are several “secrets” you can apply to your HELOC to lower payments, earn credit card rewards, and get cash back. I’ve written detailed explanations of these creative money management techniques in an ebook that can be downloaded here: http://thepayground.com/heloc_home.html.
Aaron