Pay off HEL?

[noppenbd]

We are trying to decide between paying off a Home Equity Loan (used to fix up our house) and saving additional funds in our emergency fund. Here is our situation:

Monthly net pay: $6800
1st Mortgage payment: $1070
Home Equity Loan payment: $570
Emergency fund: $7800
Roth IRAs: $25K
403b: $20K
SIMPLE IRA: $22K
No other debts

Emergency fund is in a high-yield savings earning 3.9% (and dropping). The rate on the HEL is 5.99% and the balance is about $25K. Our nominal tax rate is about 10% federal and 5% state. We are contributing the max to our Roth IRAs this year.

In addition to the 1st mortage and HEL, we have a HELOC with zero balance, $37K limit, and 6% variable rate, which could function as an emergency fund.

With about $2K a month left over to allocate, should we

a) continue contributing to E-fund to get 3-6 months expenses, then pay off HEL
b) stop contributing to E-fund, pay off HEL balance, then resume E-fund contributions
c) put most of E-fund towards HEL balance, pay off remaining HEL, then build up E-fund again
d) none of the above!

Thanks for any help!

[disneysteve]

If you have already maxed your Roths for the year, I would probably split the money. Put some toward the EF and some toward the HEL. You've already got a good start on your EF for most things, plus you've got the HELOC to fall back on if absolutely necessary (I'm not a fan of using new debt as an EF).

[jIM_Ohio]

We are trying to decide between paying off a Home Equity Loan (used to fix up our house) and saving additional funds in our emergency fund. Here is our situation:

Monthly net pay: $6800
1st Mortgage payment: $1070
Home Equity Loan payment: $570
Emergency fund: $7800
Roth IRAs: $25K
403b: $20K
SIMPLE IRA: $22K
No other debts

Emergency fund is in a high-yield savings earning 3.9% (and dropping). The rate on the HEL is 5.99% and the balance is about $25K. Our nominal tax rate is about 10% federal and 5% state. We are contributing the max to our Roth IRAs this year.

In addition to the 1st mortage and HEL, we have a HELOC with zero balance, $37K limit, and 6% variable rate, which could function as an emergency fund.

With about $2K a month left over to allocate, should we

a) continue contributing to E-fund to get 3-6 months expenses, then pay off HEL
b) stop contributing to E-fund, pay off HEL balance, then resume E-fund contributions
c) put most of E-fund towards HEL balance, pay off remaining HEL, then build up E-fund again
d) none of the above!

Thanks for any help!

d) none of the above

You did not mention age, but guessing late 20's to early 40's. My advice is to up the retirement accounts while slowly increasing EF.

You also did not mention total monthly expenses (guessing $4800), so EF is currently 1.5 months expenses.

I would do the following up 403b and SIMPE ira contributions. Maybe $800/month total. If you are not comfortable with this, then add $800 to a taxable account for purposes of retirement. I assume Roths are maxed when making this recomendation.

Add $800/month to EF. SIMPLE ira suggest one spouse is self employed, I would get EF to 6-12 months expenses to at minimum cover 1 years pay for self employed spouse. I would keep 1/2 of EF in cash, I would put other half in a moderate investment (like a 20-80 mutual fund like RPSIX or moderate allocation mutual fund like PRPFX).

I would add $400/month to a taxable investment account which is for diversified expenses.

If first choice I gave you meant "taxable account" for $800/month, then you are investing $1200/month in taxable accounts. Put 2/3 of this into a diversified growth portfolio, the other 1/3 into a conservative growth portfolio.

2/3 growth is for retirement- 67k currently in retirement accounts is not enough to replace the $82,000 you take home each year.

1/3 moderate growth is for high expenses and short term income replacement. Things like a new roof, new car, small business catastrophe type issue.

The EF should be 12 months expenses for self employed spouse and probably around 6 months expenses for whole household. I would use the EF for loss of job or health care crisis only.


If the SIMPLE ira is not for a self employed spouse, I made a bad assumption. I would then temper down to 6 months cash in EF, investing the rest.

I would not be looking to pay down HELOC until retirement accounts are 2X income and EF is 6 months expenses. The problem you have is a good one to have (where to allocate 2k per month). If my advice is too aggressive, drop the $400 I suggested towards catastrophe fund to $200 and pay down HELOC with other $200.

Being in 10% tax bracket with income of 80k is impressive.

[noppenbd]

Oops, I am in 25% tax bracket, but with deductions it ends up about 10% nominal (11K on 110K gross yearly income). Sorry if that confused the issue. The 2000 spare was not including Roth contributions. Assuming we are maxing it out for 2008 we will need to use about 1000 per month for rest of the year.

Not counting the 2000 extra, we are putting 250 a month into the SIMPLE (not self-employed, just a small company), plus the employer match, which will end up at 500 a month. In addition we were going to put 120 a month into the 403b. Total including matches would be 620 a month. Sounds like we need to up that a bit. So let's say we raise it 180 to 800 a month including matches. That still leaves 1800 a month spare, 800 after Roth contributions.

It sounds like paying off the HEL should not be a major priority at this point.

I would like to have some savings for travel and other future large purchases not locked away in retirement. So how about putting 500 towards EF until we reach 26K (approximately 2 years), and the remaining 300 in intermediate term savings?

[Snave]

Just food for thought. I know the HELOC is a variable rate, but with interest rates going down, this is going to be affected and drop lower. My guess is you have a prime rate = 3% short term + 3% your bank adds on to get prime rate of 6% now. If the rates drop more, you might want to move your HEL over to teh HELOC and pick up a few bucks saving on interest. This could seem risky b/c it is variable, but the rates have no indication of going up soon. Again, I wouldn't do this until short term rates dropped another 1/2 point or so.

[noppenbd]

Snave, I thought about doing that but I have a feeling interest rates are going up next year due to inflation concerns. So if I did move funds to HELOC I would not do the whole thing, probably just 1 year's worth or so. What do you think?

[jIM_Ohio]

Oops, I am in 25% tax bracket, but with deductions it ends up about 10% nominal (11K on 110K gross yearly income). Sorry if that confused the issue. The 2000 spare was not including Roth contributions. Assuming we are maxing it out for 2008 we will need to use about 1000 per month for rest of the year.

Not counting the 2000 extra, we are putting 250 a month into the SIMPLE (not self-employed, just a small company), plus the employer match, which will end up at 500 a month. In addition we were going to put 120 a month into the 403b. Total including matches would be 620 a month. Sounds like we need to up that a bit. So let's say we raise it 180 to 800 a month including matches. That still leaves 1800 a month spare, 800 after Roth contributions.

It sounds like paying off the HEL should not be a major priority at this point.

I would like to have some savings for travel and other future large purchases not locked away in retirement. So how about putting 500 towards EF until we reach 26K (approximately 2 years), and the remaining 300 in intermediate term savings?

I do agree delaying the HELOC payoff to get cash in the bank makes sense. However further comments by you changes the picture I originally painted- see red above.

I would first start by asking another question-

110 was gross income.
What was AGI on 2007 tax return?
What was taxable income on 2007 tax return?

My AGI was around 110 with taxable income at 62k for 2007. The taxable income determines final tax bracket (which I am guessing is in 15% bracket for you based on taxes you said you paid).

2k extra.

Put $500/month into Roth for spouse 1
Put $500/month into Roth for spouse 2
put $500.month into EF
put $250 into intermediate savings
**put $250 into 403b or simple IRA.**

**The last bullet can really help you if you know your taxable income. 15% bracket tops out at $65100. If you keep your taxable income below this, you will be saving yourself considerable current tax dollars ($65101 dollar is taxed at 25%). The only contribution mentioned above which reduces taxable income is the Simple IRA or 403b. The interest earned on EF and intermediate savings will increase the taxable income.

In November and December the IRAs will be maxed out (not in 2008 if you have not contributed yet)- when this happens turn IRAs off for 2 months and put the extra $2000 into an intermediate term investment.

I use that IRA technique (maxing in August) to balance out any withdraws from emergency fund during the year.

[Snave]

Snave, I thought about doing that but I have a feeling interest rates are going up next year due to inflation concerns. So if I did move funds to HELOC I would not do the whole thing, probably just 1 year's worth or so. What do you think?

It's probably not going to save you a whole heck of a lot, so it might not be worth teh hassle.

[Merch]

I would pay off HEL. If you pay of the HEL then your emergency fund would need to be less since you are eliminating some of your expenses.

Also, since the HEL is 5.99% and ING is 3.99%, you are losing 2% on the arbritrage.

As for Roth, if you paid off the HEL, you could redirect that monthly payment to either the EF or the Roth IRAs.

[jIM_Ohio]

I would pay off HEL. If you pay of the HEL then your emergency fund would need to be less since you are eliminating some of your expenses.

Also, since the HEL is 5.99% and ING is 3.99%, you are losing 2% on the arbritrage.

As for Roth, if you paid off the HEL, you could redirect that monthly payment to either the EF or the Roth IRAs.

Consider that HELOC looks to be on a 5 to 10 year repayment schedule, so paying it down would still have the expense in EF for around 10 years. 2k extra to it pays it off in 2 years, so that is still 2 years of "living on the edge" with a low EF, when one employer is a really small company.

I think cash over those 10 years will compound faster in other places. One reason I suggest a portion of money to a taxable account is so if HELOC rate (payment) increases, there is cash available to keep it under control. $3000 per year ($250/month) is a good amount to set aside and grow (in 10 years at 7%, this compounds to 44k), which is almost 2X the amount owed on HELOC. At year 4,5, or 6 there will be enough set aside to pay off HELOC and free up the $500/month payment if needed.

Getting the EF funded with $500/month, and added to the $7800 now puts EF at $13,000+ in 12 months. This would be close to 3 months expenses. In 12 more months OP would have 4 months expenses, in 4 more years ($7800+6*6000) all 12 months expenses. HELOC would be paid off close to then anyway.

I could see some debate to getting EF to 3 months (meaning 12 months of $500 to EF) then using $500 to pay down HELOC. Heloc payment is 11% ($570/$4800) of budget. Removing it does not save OP much room in EF (might make 3 months expenses become 3.5 or 4 months expenses by removing debt).

I do emphasize liquidity over cash flow in this case because the OP has employment from a small company. This is quite volatile, and tieing up assets in illquid investments (HELOC) without paying it off is a cause for problems. OP is better fully leveraged with cash or completely paid off- the in between state does little to reduce risks of situation (IMO).

If a layoff occurs liquid cash can cover the bills short term. A paid off HELOC would not cover a mortgage payment 2X the size or any other bill. I would keep liquidity with such a small employer until the cash balance was enough to pay off the whole debt. Again stay leveraged in HELOC until OP can pay it off is my advice.

I have no issue with working for a small employer, but risks change with small employers quickly. They have lower severance packages, plus more volatile employment (meaning bad times could mean a quick layoff at an unexpected time). The way to counter that risk is to have a high amount of cash on hand.

[noppenbd]

Thanks for all the feedback and advice.

First off, to clear up a few issues, we have 3 mortgages. 1st is fixed at 5.375, balance of 140K, payment of 1070. 2nd is the original HEL I was asking about, fixed at 5.99, balance of 25K, payment of 570 (about 4 years remaining). 3rd is "emergency" HELOC, variable at 6.0, zero balance, limit of 37K.

Looking at my 2007 tax return, gross income was 116, AGI was 108 (after 5K in dependent care FSA and 3K SIMPLE IRA), taxable income was 75K.

So I don't think we are going to get to 65K taxable with SIMPLE/403b contributions. I am actually more worried about future tax increases, hence the tendency towards the Roth IRAs.

Here is what I think we are going to do:
-Leave HEL as is, paying minimum for next 4 years until paid off
-Leave HELOC in place as secondary EF
-500 each to 2 Roths until fully funded for 08
-keep 250 going to SIMPLE
-keep 120 going to 403b
-500 towards EF until we reach 3 months expenses
-remaining goes into intermediate savings which could also be used as emergency funds

Thanks for all the help! This is a great forum!
-Dave

[jIM_Ohio]

Looking at my 2007 tax return, gross income was 116, AGI was 108 (after 5K in dependent care FSA and 3K SIMPLE IRA), taxable income was 75K.

So I don't think we are going to get to 65K taxable with SIMPLE/403b contributions. I am actually more worried about future tax increases, hence the tendency towards the Roth IRAs.

If you think about it, you are putting 10k into Roths. 10k would also lower you into 15% tax bracket, whch would increase your tax refund, which could be put into a Roth. Tax savings on 10k is $2500, so this technique would get 12500 invested instead of 10k.

There might be more efficient ways to make money work is my point.

75% of the country has highest taxable income in the 15% tax bracket, so you are in top 25% wage earners for country.

I have no problem with the plan you suggested, I am just pointing out other issues (with the new information you provided).

[noppenbd]

Jim, I see your point. Still, since tax rates are at historic lows, I think I would prefer to keep contributing to the Roth. Plus, your analysis isn't totally fair, since at least 10K of the contributions would be in traditional IRAs and thus subject to ordinary income tax when withdrawn. So 10K in a trad IRA is only "worth" 7500 in a Roth @ 25% tax rate. And that is assuming tax rates don't go up, which they probably will (what with Medicare and SS so underfunded).