Logic on deciding which loan to pay off

Paying off a loan at 6.75% gives you a *guaranteed* return of that much. You can't say that about stocks.

If you pay off a loan, your monthly expenses will be that much lower, so you won't need such a big emergency fund. It's generally not considered such a good thing to keep your "emergency fund" in stocks, either; what if you have an emergency when your stocks are down 20 or

30%? (Look at what the market did on 9/11 for an example.)

The real problem is that you *bought* the asset that is shrinking in value to begin with. You have to pay for it sooner or later. If you now think that wasn't such a great idea, can you sell the truck and replace it with a less expensive vehicle? Or with your feet? ;-)

Personally, if it were me, I'd pay off and/or sell the truck and start putting half the money you save on its monthly payment into a cash emergency fund and half into paying off the 8.75% HELOC.

-Sandra the cynic

I look at it by the type of debt. A mortgage is an OK kind of debt. It is better to not have to have one, but few people can buy a house without one. At least the item behind the mortgage, the house, generally holds its value over time.

A HELOC loan is a poor kind of debt. Mostly because people use them to convert short term debt into long term debt, and convert unsecured debt in a debt with your house pledged against it.

A car loan is an awful kind of debt. It is debt for an item that goes down in value just by sitting, and an item that has virtually no value in 4 to 6 years. You should never fall into this trap.

So, my action would be to pay off the car loan first, then go after the HELOC later on. An 8.0% HELOC isn't so bad if it is fixed, but if those puppies adjust up, they start falling into the high risk zone of interest rates. You don't want to be paying

10% for HELOCs.

I think you have it exactly backwards. I see it as OK to have debt against something that holds its value, especially like a house where you have to have shelter, and it sometimes even goes up in value. A car is not an asset, it is an expense. Its value withers away over time, so you never want to owe more than what its current value is. If at all possible, you want to owe less than its value so you don't get hurt so bad if the car is wrecked.

-john-

Of course, we'd have to ask about the 'rest of the story'. Where do your retirement accounts stand? Do you have a 401(k)? Is the employer matching? Do you deposit enough to capture the match? Any Roth IRA?

For the above, both say "second mortgage". What about the first mortgages? On the house you live in, is the first mortgage in line with what's available now? (There are no point, no closing re-fi's, so exchanging the rate you have for a better one, and maybe combine the second into it is the way to go.)

To Sandra's point, there's a grey area where paying off doesn't make sense, say a 5.25% fixed. We are in a part of the cycle where the risk free rate is near or above that. But at 8.75%, I'm with her. And you can always borrow the money back if need be. (As compared to the car loan, once paid, you can't just write a check and get it back).

Without knowing the rest of the details, I'm in favor of paying off the

8.75 heloc early. Tell me your not making enough 401(k) deposits and your employer matches the first 50% dollar for dollar, and I'm sending you there.

JOE

Thanks for the responses guys, a different point of view was exactly what I was looking for.

You guys had quite a few follow up questions and I will try to address those here:

Sandra:

1. Good point about paying off a loan to guarantee a certain return, that logic would seem to point to the 8.75% heloc, except for the tax deduction which means I am not really paying 8.75%. How would I calculate the actual interest rate after the tax break?
2. When I buy vehicals I try to buy the best quality I can with plans to own for that vehical for 10 years. The last truck I had, which I traded in on this new one, was a 1995 Dodge and had 220k miles. Buying this new truck (by the way it was not *new*, it was a used truck even though I refer to it as new) was not a luxury, the trade in value for my old truck was 00 and it would have cost me roughly 00 to fix all of the mechanical issues it was having.
3. Walking everywhere I go and/or using public transit is not an option.

Mark:

1. I am currently paying against the principal of both the helocs, not much but better than nothing.

Joe:

1. Retirement accounts, 401k contribution is 10% and I get the max match. Also max contribution to Roth IRA every year for the past 7 years. I send 0/week to my brokerage company held in a money market then use that to make the roth contribution within the first 2-3 months of the new year. So I already have the 2007 roth contribution ready for Jan 1st. The cash for the 2007 roth contribution is NOT what I was considering to use to pay off the loan. I will be 33 in March and just last week for the first time my retirement accounts closed above 0k, I was pretty happy about that althought I do not know how that compares to others in my age group.
2. I have not done any comparison shopping on current mortgage offers so I am not sure how they compare to what I currently have. Maybe I should do some checking on that.
3. Very good point about being able to borrow against the heloc if I were to pay it off and not being able to borrow against the truck.

With everyones comments and my own thoughts, I think paying off the

8.75% heloc then using the additional cash flow to pay down the truck and increase my emergency fund sounds like the best option.

Let me know if you guys have any additional comments and thanks for taking the time to respsond.

Sam

Do you have enough other deductions on your taxes to itemize even if you pay off the HELOC? If no, your effective interest rate is the full 8.75%. If yes, what's your tax bracket? Say you're in the 28% bracket; then your effective interest rate is (1 - 0.28) * 8.75 = 6.3%. If your tax bracket is higher the effective interest rate is lower, and vice versa.

-Sandra

see

it will give you the standard deduction (which, if you don't exceed by itemizing, your interest rates are the real rate you pay) as well as the chart for tax brackets. When you have a mix of deductible and non-deductible loans, it's a good exercise to line them up, post tax. There is a gray area, where one might tell you to pay off the $2000 left on your 6% loan to free up that payment, i.e. pay the smaller amounts to make faster progress. I respectfully disagree. I ask what is your post tax interest cost each year, and what is the most expensive loan.

You sound like a saver with access to low interest money (i.e. not a credit card). If you do itemize, and are in the 25% bracket, the B heloc is costing you 6.56, and the truck 6.75. Too small a delta to call. Only you can decide the value in accessing that money again.

Other than that, I believe you are on the right path. $100K saved if you make $35-$40K/yr is on track. If you make much above 50-60K, you may have some catching up to do. Of course that $100K ignores the equity in both homes, so you may be way ahead.

JOE

Since HELOC A was on a rental property (with positive cashflow even), would the interest paid be a business expense on Schedule C even if he doesn't itemize deductions? Or is just its first mortgage a legitimate business expense? (maybe it depends on how he spent the HELOC money)

In any case, I vote for paying off HELOC B first, then apply the freed-up cashflow to paying off the truck. Don't close the HELOC when it gets to zero; you might need to tap it again later.

Best regards, Bob

Mortgage interest on a rental property is a fully deductible expense on Schedule E (not C).

Otherwise, mortgage interest on a primary residence and a second home are deductible on Schedule A if qualified.

So yes, the tax implications of the two HELOC's should be taken into account, which depends on filing status, state of residence, and so on.

-Mark Bole

HELOC A interest basically nets out with income as OP states positive cash flow. Rent, interest expense, repairs, depreciation, etc, all are added together, and appear on SCH E, certainly not C.

JOE

Yep. It's been so long since I owned any rental property, I forgot there's a separate tax form for it rather than just reporting as business income.

The point I was making is that HELOC A and B are not equivalent for taxes, and A might be deductible even if B is not (which you and Mark confirmed)

-- then I made a fool of myself by mentioning the wrong tax schedule :-)

Bob

Not a fool at all. HELOC A is subject to his marginal rate regardless of itemizing as Schedule E has its own form and line on 1040. So paying down HELOC B which is the higher absolute rate anyway seems to be the popular response. As you said, HELOC B may not be deductible, your observations are well noted. JOE

Something else to think about - is the Automobile loan a Rule of 78 loan? If so, paying it off early - unless it is really early - may not get you as much as you think, since you've paid extra interest up front.

2) (heloc on house you own) then

either

1) heloc on rental and 3) car or 3) car and 1) heloc on rental

2) because this is highest interest and house you live in, make sure you own this free and clear. Because this rate is adjustable and higher, I am suggesting you pay this off first.

3) pay off car next, this assumes you can raise rent to account for any changes in the adjustable part of this payment (if rate goes up, pass this cost onto tenants).

1) pay off car. lowest rate, pay off last.

This reduces overall interest paid, without regard to tax deductions. I am thinking of "risk"- because the car payment is not adjustable, I am thinking it is the least risk to you to have this debt- car insurance should also cover most of this if car is unusable (we have a clause on our car insurance that the insurance will payoff the car if in an accident).

I might suggest doing 2) and 3) at the same time- pay more principal on both (maybe $100 extra on each per month). Then throw an extra $100 towards the heloc. When heloc is paid off, put all this money towards car.