Paying off HELOC vs. Saving?

[Phatphoeater]

I'm learning that digging into personal finance is a never ending process. My first thread re: where to park extra monthly cash has gotten me thinking about other uses of cash surplus in these times of relatively low savings account interest rates.

For a brief breakdown of my fundamentals here is the first post. www dot savingadvice.com/forums/personal-finance/45001-where-park-extra-savings.html

I have a $90K Heloc @ 6.25% variable 3+prime. Applying $1k/mo on top of the monthly yields of total of $50k (HELOC) in interest savings with a payoff in 5-ish yrs.

My ING account is @ 1.65%. Using a compound interest calculator, it looks like over the 5 yr period I'd earn about $2.5k in interest (minus 28% taxes owed).

My inclination is to save money but given the environment and the high probability the prime rate will rise due to inflation, it makes sense to pay off the HELOC, right? Is this kind of decision made purely on calculating interest saved vs interest earned?

[creditcardfree]

Assuming that extra cash is NOT your emergency fund or something you might need in case of a layoff, I would pay off the HELOC.

I'm actually doing that right now. We have our emergency fund, and my DH's military job is stable, so our extra cash is going to pay off our home equity loan. We started the year with $13,999 balance at 7.25%. So far, we've paid it down to under $8K. I'd rather have this loan off our back, then the few pennies I could make in interest!

[jIM_Ohio]

If there is inflation you will want the HELOC and similar debt.

I would maintain liquidity. I would not look at the 50k "saved" in interest. Put the 1k per month extra into a savings account (or CD) and once you know you have enough liquidity, send larger payments to the HELOC.

Meaning pay maybe $200/extra month to HELOC
keep $800/mo in cash or CDs.

Then when the cash hits 10000, send $5000 to HELOC and still keep $5000 in cash. Repeat when you get to $15,000 (send $7500 and keep $7500).

Keep increasing liquidity until you see rates start to go up.

[Phatphoeater]

Originally Posted by jIM_Ohio

If there is inflation you will want the HELOC and similar debt.

I'm not sure I understand this point. I thought the prime rate goes up in inflation to make $$ more expensive. Wouldn't that send my prime + 3% upwards? Being a newbie, I must be missing something.

Also, is there some understood percentage of liquidity beyond an EF that is advisable? There are certainly things that come up that may require large sums of cash that we can't foresee. Is it these things that require liquidity in excess of an EF?

[creditcardfree]

Jim, I'm not following your theory either. Please explain a little more!!

[MiikeB]

If everything costs more, his debt essentially becomes "worth less." Where as his debt may have been worth so many gallons of milk @ $4 a gallon. If milk goes up to $6 gallon his debt is worth so many gallons less.

Also, with inflation in theory salaries go up so it becomes easier to pay his debt.

[GREENBACK]

Originally Posted by MiikeB

If everything costs more, his debt essentially becomes "worth less." Where as his debt may have been worth so many gallons of milk @ $4 a gallon. If milk goes up to $6 gallon his debt is worth so many gallons less.

Also, with inflation in theory salaries go up so it becomes easier to pay his debt.

I see the debt being worth less but, as suggested, if the interest rate rises doesn't that offset things.

[jIM_Ohio]

Originally Posted by creditcardfree

Jim, I'm not following your theory either. Please explain a little more!!

The conventional wisdom in high inflation environment is to hold debt. Ask anyone which owned a house and mortgage in the 1970's.

Logic is that you lock in a payment, and then repay it 30 years later with dollars worth a lot less than what the dollar was worth when you bought/closed on the house.

HELOC could adjust upward, so the issue "is the increase in interest rate higher than the inflation rate" comes into question. If the rate was fixed, keeping the debt is a no brainer.

[Phatphoeater]

Originally Posted by jIM_Ohio

HELOC could adjust upward, so the issue "is the increase in interest rate higher than the inflation rate" comes into question. If the rate was fixed, keeping the debt is a no brainer.

This I understand, thank you. But to go back to the issue of liquidity you mentioned above, is it liquidity for liquidity's sake or is there an assumption you could earn more in savings interest vs. paying down debt?

[creditcardfree]

Thanks Jim! Make sense.

[GREENBACK]

Yes, that does make sense.

[jIM_Ohio]

Originally Posted by Phatphoeater

This I understand, thank you. But to go back to the issue of liquidity you mentioned above, is it liquidity for liquidity's sake or is there an assumption you could earn more in savings interest vs. paying down debt?

Liquidity trumps rates of return in this climate, IMO.

This was not my outlook 2 years ago or even a year ago, but that is what I am thinking now- cash is better than rate of return.