Re: taking out a home equity loan in order to pay down student loans

Hi all.
> > I did the following rough calculation on the potential benefits of taking out a home equity loan in order to pay down a student loan (of size $113,000). We cannot deduct student loan interest because our household income is too high. So an accountant mentioned the possibility of taking out a home equity loan (HEL) and deducting the interest from that HEL loan. > > Assuming a 3.85% HEL interest rate, and a HEL loan of size $113,000, to be paid back over 15 years. Total yearly HEL interest, potentially tax deductible, is about $4,200. Assuming our top income tax rate is 28%, we save $4,200.28=$1,176 on our taxes. > > We are losing about 3.85-2=1.85% in interest rate, since the student loans have a 2% interest rate. A 15-year loan of $113,000 at 1.85% has a yearly payment (int+principal) of $8,628 per year. That is a big loss that largely offsets the tax savings. > > Is there anything wrong with my thinking? > > Thanks in advance for your input >

Forgetting for a moment the time value of money....

A 15 year loan of $113,000 at 2% equals payments of $130,890. Use 3.85% and the payments are $148,928. That is an extra $18,038 of interest. A HELOC of $100,000 (that's the max on which you can deduct interest) at

3.85% would have payments that equal $131,795. That is deductible interest of $31,795. A 28% tax benefit on $31,795 is no where near your additional interest of $18,038.

I would (almost) never pay off a loan at 2% interest. Assuming you have adequate income and assets overall, I'd pay the minimum and invest the remainder.

If the 2% is a variable rate it might be a different story, because variable rates will go up when the Fed starts raising interest rates. (It's a certainty they will; when and how rapidly is another matter.)

Also I think interest deductions on HEL's not used to purchase or improve a residence are limited to the first $100,000 of principal. And you might find later on you have other reasons to want to tap the equity in your home.

If you were paying a higher interest rate on the student loans it might make sense, but at 2% it makes no sense at all.