9

Home Mortgage has 18 years left and is at $184,000 principal with a monthly payment of $1135 and an APR of 3.15%

HELOC has $24,000 principal left with a monthly payment of $400 and an APR of 5.5%

I have paid roughly $1260 into our mortgage per month for the past 2 years and I plan to pay $400-500 per month on our HELOC.

We plan on staying in the home for about 8-9 more years, then downsizing. No other credit debt - just monthlies and car payments.

Should I use the $125 extra I have been paying into my mortgage to pay off the HELOC faster, continue to use it to pay off my mortgage faster, or save it for other things?

Thanks in advance

  • 1
    Do you have an emergency fund (3-6 months of expenses in case something happens, plus at least $1,000 for big unexpected purchase)? – GOATNine Oct 12 '18 at 17:37
  • 2
    we have about 3 month saved away. – Troy Kunze Oct 12 '18 at 18:33
  • 3 months should be enough barring other risk factors (like single income family or both of you in the same field or at the same company) – J. Chris Compton Oct 12 '18 at 18:41
  • 5
    What are the balances and rates of the car payments? Are they loans or leases? – stannius Oct 12 '18 at 19:16
  • 1
    You still need insurance on cars, least if you want insurance after the car is in an accident. It isn't there just for the lender. – Harper Oct 14 '18 at 0:14
13

Pay the loan with the highest interest rate first. If the rate of your car loan is higher than 5.5%, pay it first.

Theoretically, if you can find a reliable investment with rate higher than those of your loan/mortgage, you should invest instead of paying off loans. However, it might be difficult to find such an investment.

  • Interest rate isnt the problem. Debt is the problem. Traction is made faster when you do the snowball method paying your lowest balance debt to highest then when those are cleared put everything extra into the house until it's gone. Include the HELOC in the debt snowball. Will be posting a better solution when I get home from work. But I do find the advice given to invest and hold loans bad advice. So you invest, gain interest and then pay it out on loans. Pretty bad strategy. – Mike Oct 12 '18 at 20:38
  • 4
    Interest rate (APR to be exact) is the only factor influencing total interest paid and thus time until the last loan is paid off (assuming that additional payments are the same in both cases). – xyious Oct 12 '18 at 20:42
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    If you rapidly pay off your debt there is no worry about interest. The best advice is to pay off the debt as fast as you can and be debt free and invest in your future and retirement. A basic emergency fund is a must before all this – Mike Oct 12 '18 at 20:44
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    @Mike: This is just psychobabble. Pay off the highest interest rate first. – jamesqf Oct 13 '18 at 16:40
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    The huge insurance paid on the two garbage car loans utterly dwarfs every other line item. The reason everyone says "Never buy an expensive car" is that you are forced to carry ultra-expensive insurance on the garbage loan. – Fattie Oct 13 '18 at 22:57
12

I'll agree with GOATNine's comment about having an emergency fund of 3-6 months expenses.

If you've done that (and you should if you're home owning and not home renting) then I would put the extra towards the HELOC as the interest rate is higher.

However, you mention car payments.

So, this isn't what you asked, but here's what I'd advise:

Stop paying extra on the house and HELOC. Apply the extra money to the car with the lowest loan outstanding. When that car 1 is paid off, put all the money you were paying extra + car 1's car payment amount as extra against car 2's remaining loan.
When that loan is paid off, apply that big pile of extra money to the HELOC, then apply to the house.

If you want to start a saving a smaller than car payment size amount into a separate bank account as a kitty for replacing the cars (which will go down in value and wear out) that would be fine too.

  • 13
    @TroyKunze fyi, smallest first is a psychological thing; if you can be disciplined about it it's financially better to pay off the highest rate first. – Kevin Oct 12 '18 at 20:00
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    ^this. Short term debt tends to have higher interest rates than long term debt. Pay off whatever has the highest interest rate and continue down the list. – xyious Oct 12 '18 at 20:43
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    WRT emergency fund and HELOC, I'd think it'd depend on exactly how it's set up. If it is indeed a "line of credit", then anything the OP pays into it would be available for emergencies. E.g. the HELOC is max 20K, he takes an initial draw of 10K, and pays back 5K. He should then be able to take out up to 15K if needed, no? – jamesqf Oct 13 '18 at 16:45
  • @user13972 a good point to keep in mind if there is any risk you'll default, but car, HELOC, and mortgage loans, the only three relevant to this question, are all secured. – Kevin Oct 13 '18 at 22:43
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    @user13972 and Fattie: comments are for improving answers, not for arguing about your opinions on auto insurance. Take it to chat. – stannius Oct 16 '18 at 17:51
1

Assumptions:

  • Paying down debt will not tempt you to incur more debt.
  • You are not itemizing your tax deductions.
  • Your home equity is large enough that -- even if there were a banking crisis -- your bank is unlikely to renege on your HELOC credit line.
  • Your HELOC is your only tappable credit line with a (reasonably) permanently low interest rate.
  • Your minimum monthly payment on your HELOC is proportional to your HELOC balance.
  • Your car loan interest rates are similar to your mortgage and HELOC interest rates.
  • You do not want to make risky investments.

Under these assumptions, your best choice is to put the $ 125 per month that you are making in extra principal payments towards the HELOC, not towards the first mortgage. Here are the advantages of this approach:

  • More liquidity. If you need to, you can re-borrow this extra payment from the HELOC. You cannot re-borrow extra payments you make toward the first mortgage.
  • More liquidity. As you pay down your HELOC, your minimum monthly payment will decrease.
  • Interest savings. If you are not itemizing your tax deductions, your effective after-tax yield on "investing" in paying down the HELOC is 5.64% per year. This is a low-risk return. (5.64 % = (1 + 0.055 / 12)^12 - 1). This return is considerably higher than the corresponding 3.20 % annual return from paying down the first mortgage.

Notes:

  • If you increase your HELOC payment from $ 400 per month to $ 525 per month, you shorten your HELOC payoff time from about 71 months to about 52 months: 19 months shorter.
  • If you increase your HELOC payment from $ 500 per month to $ 625 per month, you shorten your HELOC payoff time from about 55 months to about 43 months: 12 months shorter.
-2

I'm a personal finance coach and I've walked many people out of the issues you're having. I understand what you're asking but I feel you've missed some important things you should consider. And some things were not told to us so I'll address them also.

1a. You need to change your mindset as to your spending habits. You've accumulated a sizable debt which is normal in today's society and culture. You must promise yourself you will never borrow money again, ever! With the exception of buying a house but only under very specific criteria to ensure you can afford to pay it. If you can't do step #1 then you will not be successful with money, and you will continually kill off your biggest wealth building tool, you're income. Stop all retirement savings temporarily. At this point you're not doing yourself a favor by paying interest and putting into retirement at this point. You will turn this back on down below.

1b. You must create a detailed budget. There are a ton of free websites such as everydollar.com mint and others which are no cost and is a zero based budget where every dollar can be accounted for. You have to set yourself up for success. You cannot unless you do regular budgeting.

  1. Do you have a baby emergency fund of at least $1000 in the bank? This should be money only used in case of an emergency. That $1k in some circumstances should be more but this for now is the minimum emergency fund to keep you from going back in debt. If you dont you need to start here. It's one of the most important thing you need to prevent you from going back into debt. If you use it you fill this first before paying extra anywhere. Use only the minimum at this point everything else liquid should be used in the below step.

  2. With a baby Efund in place you start the debt snowball. List all your debts not including a mortgage from smallest to largest. Paying everything you have extra into the smallest balance debt, but still ensuring you pay the minimums on the rest. Once the smallest is knocked out you roll you roll the money you were paying into the smallest into the next smallest plus that minimum payment. Doing the debt snowball method you can not just pay down debt rapidly but you also get traction. It is by far the best method to get out of debt. Your HELOC is treated like a credit card and should be in your debt snowball in the order lowest to highest.

  3. The debt snowball is now complete in this step. You will fully fund your emergency fund with 3-6 months of expenses. This will be your perminent rainy day fund same as the mini which you should have at least $1k already but this will be enough to cover whatever emergencies are thrown at you such as job loss, car accidents, etc. This fund is not for saving up for things this is only for emergencies.

--- you will do the below steps all at the same time

  1. Next once your fully funded efund is complete you will invest 15% of your household income into retirement. Utilizing roth IRAs, 401ks, to invest into your future with mutual funds spread over 4 categories: growth, aggressive growth, growth and income, and international.

  2. Start college funds for your children if you have them.

  3. Pay down your house and pay it off early. At this point you have a fully funded efund, a great plan to build wealth for retirement and now you will have a ton of extra cash because you are debt free to pay off your house.

  4. Build wealth and give.

PS: I dont know the financial details of your mortgage and debt based on your post. Buying another house is expensive because closing costs are expensive. $6-10k+ depending on the loan value. It's hard to give you advice on your home without all the details. Most people can get out of debt while in their house unless they're so house poor they have no money free. If that happens to be you then I recommend selling the house, have enough money for a security deposit, first and last months and rent until you're debt free. Once debt free save up a sizable down payment, obtain a mortgage on a 15 year fixed with a payment no more then 25% of your take home pay. This way your house will be a blessing instead of a curse. Buying another house while in debt is a very bad idea. The method I explained here has been out for 30 years now and has successfully got millions of people out of debt. It's a proven plan but you have to be willing to do it scorched earth. Get out of debt as fast as you can throwing everything into it.

  • 4
    Welcome to Money.SE. You answered this question as if the OP has a credit card "problem" as opposed to the situation and very simple question he described. Not all questions invite the Dave Ramsey lecture. 3-6 credit cards? You want to talk debt snowball, go ahead. Pay mortgage faster or HELOC? DS not really the answer, albeit, the result may be the same. "Another house"? The guy is talking about a downsize, how does that strike you as a bad thing? – JoeTaxpayer Oct 16 '18 at 13:24
  • So in post the OP admitted to car payments, HELOC (credit card on your house), and a mortgage. He wants to move small payments to something else as if it will solve his problem. It won't unfortunately. No lecture, just plan. He can use it or he can not use it. It's up to him. I gave him an effective plan to get out of debt. Unless of course his goal is to be in debt for decades or maybe his whole life like a lot of people. – Mike Oct 16 '18 at 13:31
  • Buying houses while in debt is just plain stupid. Yes,people do it all the time, and there are a lot of people that are broke, struggle for decades living paycheck to paycheck, and some lose their houses too. Yes buying houses in debt is a bad thing. – Mike Oct 16 '18 at 13:33
  • You're welcome, JoeTaxpayer. – Mike Oct 16 '18 at 13:34
  • 3
    Love the enthusiasm, Mike, but I have to agree with @JoeTaxpayer here - a bit of an aggressive response (both this answer and other comments) to the OP's stated query. Nothing about OPs question suggests they're living paycheck-to-paycheck or struggling with an oppressive burden of inexorable debt... – johnny Oct 16 '18 at 19:08

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