Should I pay additional principal on mortgage or pay down HELOC?

[msnln]

Over the past few years, I have been focusing on prepaying my primary mortgage but with price of everything going up, I am starting to get concerned about potential inflation on the horizon. My mortgage is 5.25% and my HELOC is prime minus 0.25% @ 2.75% today. Because of such low rate on HELOC, I have just been paying interest every month. As far as I know, there is no cap on the HELOC rate, and when the prime rate starts moving, I am concerned it will shoot up very quickly.

With the prepayments I have been making, it would take about four years to pay off the mortgage but it will take just as long to pay off HELOC, if I was to apply prepayment amount to the HELOC. What would you do? Thank you for your thoughts.

[msnln]

I just wanted to add that these are the only two loans I have left and I have been using HELOC as emergency fund. I know I should start separate emergency fund but that is something I had been putting off to pay off my cc debts (which I have successfully paid off) and these two remaining debts.

[jpg7n16]

Eliminate CC debt first (done!)
Build EF 2nd (not done)
Pay down debt/save for goals 3rd (not done)

Build your EF to between 3-6 months of expenses before paying extra on either of the loans.


What concerns do you have about inflation? Why does it bother you? Wouldn't your house rise along with inflation?

I take it due to your inflation concerns, you're probably more risk averse - is that correct?

[cschin4]

Why do you have a HELOC in the first place? To me, it is nothing more than additional mortgage except that the interest rate is not fixed. I would be more concerned about paying that especially if a big swing in interest rates occurred and it is an amount that you could not pay off quickly and be out of. I would not delude myself into thinking that won't happen. And, i would advise not borrowing against one's home in the future.

[msnln]

JPG, you are right. I have been risk averse for past year and my retirement accounts have been 50% cash (IRA, 401K, etc). I have not been as concerned about EF because I believe my investment holdings are diversified enough to provide sufficient cashflow to live on. I have few RE holdings that is giving me about 5K/month of cashflow.
The reason I am concerned about inflation is impact that will have on the prime rates. Currently, prime is 3%, but once rates move, it will move very quickly and I can see prime going up to 6% or higher in short order, usually within a year from past experiences. My interest rate will quickly double and will be higher than the mortgage rate I am paying. I will never sell any of my RE so rising value is not part of the equation.

Cschin, I got the HELOC when I bought primary residence because I bought a foreclosure that needed much improvement. The house only had walls & roof and I had to rebuild the whole inside. I had to put in over 100K of work to make the house livable. HELOC, with low rates made most sense at the time.

Thank you both for your feedback.

[jpg7n16]

Originally Posted by msnln

JPG, you are right. I have been risk averse for past year and my retirement accounts have been 50% cash (IRA, 401K, etc). I have not been as concerned about EF because I believe my investment holdings are diversified enough to provide sufficient cashflow to live on. I have few RE holdings that is giving me about 5K/month of cashflow.

If you're not as concerned with the need for an EF, then I'd recommend the lower end at 3-4 months. Though you should at least consider what happens if your rentals go vacant for a month or two (or three).

The reason I am concerned about inflation is impact that will have on the prime rates. Currently, prime is 3%, but once rates move, it will move very quickly and I can see prime going up to 6% or higher in short order, usually within a year from past experiences. My interest rate will quickly double and will be higher than the mortgage rate I am paying. I will never sell any of my RE so rising value is not part of the equation.

How do you know rates will move quickly?

I don't know how you'd know that, but let's say the rates doubled in the next year. Wouldn't it still be cheaper than your 1st mortgage?

Besides - even if it jumps to 6%, isn't that barely more than your mortgage anyways?

Since you are risk averse, I would pay extra on the 1st mortgage until the rate on the 2nd is higher than the 1st - only then would I switch and pay more on the 2nd. Right now, you'd be paying down the cheapest mortgage because of your fears about the future.

Right now your 1st mortgage is twice as expensive (5.75/2.75 = 2.09x)

If rates jump to 6%, then the 2nd will only be 4% more expensive than your 1st (6.00/5.75 = 1.04x)


So to me, it seems that you're considering paying on the one that's half as expensive, because you're afraid it's rate may jump up to what the other one's rate is. That doesn't make much sense to me.

IMO - just keep putting any extra payments towards the highest interest rate debt you actually have, and you'll be fine

[cschin4]

So basically, you have a mortgage for $100K more than you originally intended? I think that is a risky strategy and i would pay it off and also consider the possibility of refinancing to have the traditional protection of a fixed rate loan.
But, on the other hand, now that people can simply walk away from a home without much repercussion, paying off the home may not even make as much sense anymore. And, in light of that, i do have an active line of credit to pull the trigger on liquidity if needed. But, in general, i hate any and all debt so that is just my nature. I would rather own the tent outright than have a mortgage on the Taj Mahal.

[MonkeyMama]

I'd also consider the possibility of a refinance. You could probably get a fixed 4% rate, and stop worrying about creeping interest rates. I know 2.75% is nice, but 4% is pretty much the deal of the century. I'd take it!

If you want to wait until interest rates start to climb - may make sense. They don't generally shoot up overnight. You should have enough time to lock in a low refi rate if the landscape starts to change.

[maat55]

I agree with MM, personally I would not feel comfortable with a variable rate and would either pay it down first or convert it to a fixed. If I were a gambler, I might refiance with a 7 year arm, if I were convinced I could pay most of it off before the 7 years end.

[jerrycates]

I think giving more or paying more of the principal is always the better choice. It lessens the actual amortization payments doesn't it? Or did I miss something?

[Little House]

I'd split the difference; take whatever amount you're paying extra toward your principal and slice it in half, pay one half towards the HELOC and the other towards extra principal. Keep your eye on the prime rate and if you begin to see it increase, pay more towards the HELOC and a little less towards the extra principal.

As for an EF fund, you want to have something saved, even if it is 1-3 months of living expenses. Have you sat down and written out a budget? Do you have a few hundred dollars extra each month you can apply towards an EF fund? Most people do but they don't know it until they work out their budget.

[msnln]

Thank you all for your advice. I wanted to wait until I had made decision to follow up. I am in the process of refinancing the mortgage. I chose to go with 10 year fixed mortgage at 3.25%. Now that the mortgage is out of the way, I am in the process of building up my emergency fund and expect to fully fund by year's end. Then, I will chip away at the HELOC balance.

[scot184]

If you only had four years left on the mortgage, why would you refinance it?

The first would probably make more sense to pay down as the rate is higher and the balance is higher, so more interest.