Which debt to pay off first?

[WarEagle]

Long time lurker but 1st time poster and I am asking for some advice on what you would do in this situation. I have about 15k to pay off some debts, which one would you pay off first and why?

Here's what i owe:
Mortgage: 15 year fixed 5.875% rate= $120k remaining (original loan 130k, 13.4 years left)
Student Loan: 30 year 4.75% rate=21k remaining (original loan 90k, 27 years left)
Car 1: 5 year 3.85% rate=31k remaining (original loan 32k, 58 months remaining)
Car 2: 4 year 2.90% rate=9k remaining (original loan 25k, 19 months remaining)

I finished school about 3 years ago and have been very aggressive in paying off my student loans. However, should i be aggressively be paying down my mortgage since the rate is the highest? Common sense would tell me yes, but self fullfillment would be for me to pay off my student loans first. What do you think?

Thanks for your advice!

[jIM_Ohio]

payoff car 2

Car 2: 4 year 2.90% rate=9k remaining (original loan 25k, 19 months remaining)

then put 16k and the car 2 payment on car 1

Car 1: 5 year 3.85% rate=31k remaining (original loan 32k, 58 months remaining)

[Hector]

You haven’t mentioned your income or emergency accounts and other information here.

Anyways, if I were you, I would sell both the cars and will not pay 40k plus interest on it. I will buy two (assuming you need two cars: one for you and one for your spouse) used and reliable cars. After that, once I have enough emergency savings for 6-8 months (including your 15k) I will pay as much money as I can towards my mortgage because I am paying higher interest on it.

[Slug]

payoff car 2


then put 16k and the car 2 payment on car 1

I'm assuming the reasoning for this is because you can write-off the interest on the mortgage and the student loans, correct?

[WarEagle]

payoff car 2


then put 16k and the car 2 payment on car 1

Jim,

I don't understand this reasoning? If this was the case, wouldn't i be better to put the 15k towards car 1 since it has higher rate? Also, yes, the student loan interest is tax deductible up to $2500, but that would still make the interest payments on it higher then both vehicles rate?

[jIM_Ohio]

Jim,

I don't understand this reasoning? If this was the case, wouldn't i be better to put the 15k towards car 1 since it has higher rate? Also, yes, the student loan interest is tax deductible up to $2500, but that would still make the interest payments on it higher then both vehicles rate?

You did not list payments on the cars. I did a SWAG as to what paid both cars off fastest.

My logic was if you pay down the higher rate car, you have 2 carpayments for 19 more months, then you could put the extra money on car #1 for 39 more months (until paid off). Without knowing size of each payment, and using a spreadsheet, I cannot tell what month both cars are paid off.

If you pay off the other car loan (9k balance) you have that payment 100% in current cash flow now. I assumed that payment was about $400/mo (which is a normal car payment I think), but that was a SWAG too.

By putting 16k to loan of car #1, then the car payment of car #2 to same loan, I think car #1 is paid off much sooner than other situation (meaning all cash flow freed up sooner).

You did not state your goal- if your goal is less interest paid, go to higher rate loan
if goal is all car payments gone (I assumed this was the goal), you need to run the numbers for what I suggested.

There is less risk to what I suggested, IMO because you have an immediate cash flow improvement because one loan is completely off the books in one payment.

[WarEagle]

Thanks for the replies!

Here is some more info if it would help.
Mortgate with tax/insurance is $1320/month
Car payment 1 is $587/month.
Car payment 2 is $470/month.
Student loan is $436/month

My goal would be to pay the least amount of interest in the long term (to a certain extent). Meaning if that was the case, i would pay all towards my house first! But then i would have all the payments for at least 19 more months until car 2 is paid off. Even though house interest is tax deductible, the standard deduction for 2009 tax year was still greater then if i itemized so that was the route i took. I'm leaning forward to paying down student loan debt to 6k left and the goal is to have it paid off by the end of the year. Why do you think it would be better to pay car #2 off first as oppose to the student loan debt?
Thanks again for the replies!

[DavidKimball]

I am with Hector. Ditch the cars and then put that money towards the student loan and then towards the house. Get an extra job for 6 months if necessary and then massively pay it all down.

The long term stress is just not worth it.

David

[jpg7n16]

You want interest savings... so:

If your income is really high, pay it towards the student loans (student interest is not deductible if your income is too high - over $60-70k single $120-150k married)

If your income is mid-range, pay it towards the mortgage (your tax rate needs to be over 34% before the tax adjusted rate on the mortgage is less than on car 1)

If your income is lower, pay off car 2 then apply towards car 1, because the extra cash flow from not having that car payment could help keep you out of credit card debt which would be really high interest.


My guess is that you're in the mid-high range income. So if you still qualify for the student loan phaseouts as a family - the most interest will be saved by paying extra on the mortgage.

See this page from the IRS to see if you qualify for the interest deduction or not.

Tax Topics - Topic 456 Student Loan Interest Deduction

Or IRS Publication 970: http://www.irs.gov/pub/irs-pdf/p970.pdf (page 41)

[WarEagle]

I am with Hector. Ditch the cars and then put that money towards the student loan and then towards the house. Get an extra job for 6 months if necessary and then massively pay it all down.

The long term stress is just not worth it.

David

I really am not too worried about the long term stress, I am confident that i would be able to pay my bills on time. I do have an emergency fund of about 12 months. I am just looking for the best way to pay down debt with this 15k that I have saved. Thanks for your insight!

[WarEagle]

JPG,

Gross is about 120k/year so I should still qualify for the student loan interest deduction. It seems as though my best bet would be to put it towards the mortgage, even though paying the student loan off would give me a sense of great accomplishemnt!

[jpg7n16]

Yeah see so you're in the 25% bracket. So the tax adjusted rate from your mortgage would be 4.4%, your student loans would be 3.56%, cars are what they are.

Another option might be to refi the home down into the 4's - if you qualify for such a refinance. I know it's soon after you got your original one, and you'd have to do some analysis based on the points they charge, but refinancing could be a good idea no matter what the other interest rates are. The rates on your car are so low, that it makes me think your credit score would be high enough to qualify. But I don't know.

You can check Mortgage Rates Compare ARM Loans Fixed Loan Rate Mortgages by Bankrate.com for mortgage rates in your area.

If you got your house down to 4.5% or so, then the order of highest tax adjusted interest rate would be:
1) Car 1
2) Student Loans
3) Mortgage
4) Car 2

At current rates:
1) Mortgage
2) Car 1
3) Student Loans
4) Car 2

[jIM_Ohio]

You want interest savings... so:

If your income is really high, pay it towards the student loans (student interest is not deductible if your income is too high - over $60-70k single $120-150k married)

If your income is mid-range, pay it towards the mortgage (your tax rate needs to be over 34% before the tax adjusted rate on the mortgage is less than on car 1)

If your income is lower, pay off car 2 then apply towards car 1, because the extra cash flow from not having that car payment could help keep you out of credit card debt which would be really high interest.


My guess is that you're in the mid-high range income. So if you still qualify for the student loan phaseouts as a family - the most interest will be saved by paying extra on the mortgage.

See this page from the IRS to see if you qualify for the interest deduction or not.

Tax Topics - Topic 456 Student Loan Interest Deduction

Or IRS Publication 970: http://www.irs.gov/pub/irs-pdf/p970.pdf (page 41)

I am going to say this is BAD advice, and qualify this with run the numbers to be sure.

If you pay down the house first, the difference in interest paid will be a high number regardless of whether you pay more or not.

I calculate 130k on 15 yr at 5.875% rate as 66k in total interest on life of the loan.
If a 25k lump sum is applied at payment #20, the interest paid goes down to $42,000 on the loan.

My interpretation of this is you paid $25,000 to save you $42,000. This is a decent return, but without a timeline you do not see these savings until payment 136 of an orginal 180 payment schedule (meaning you reduce payment period on mortgage by 44 months (4 years) with the 25k lump sum.

Without factoring in inflation, this means you spend 25k now to save a high amount of interest, but you do not see the cash flow return on this money for another 10+ years.

Yes you can save "more interest", but without a timeline, saving on interest in this 1 isolated case is not a big enough picture.

If you pay down the cars first, the interest saved will be much clearer and sooner.

If you owe 9k on car 2, that is probably interest saved between $200 and $1000.
If you put 16k on car 1, that is probably about $1200 saved per year for 2-3 years.

I used same ammortization table on cars (that might not be right)
but here were exact numbers:

Car a 25k financed at 2.9% is a payment of $552
Car b 31k financed at 3.85% is a payment of $568

Car payment b is $587/month.
Car payment a is $470/month.

you can see the way cars are financed are not the same, but close enough for this comparison

If you paid 9k on car a and paid it off, I calculate that total interest paid originally to be $1500 and with 9k lump sum at payment 29 to be $1258 which is about a $250 savings and an improvement in $470/mo to cash flow

If you paid 16k on car b and then added the $470/mo to it, the original 5 year interest was $3100 and with just 16k lump sum at payment 4 knock interest to $920 ($2200 savings). Add the $470/mo to the payment plan every month after is a total payoff of both cars in 15 months and interest savings paid on car 2 was $683 ($2500 savings).

Then take both car pauments ($1000/month) and add that to mortgae 17 payments after today (I used payment 41 on ammortization table, that is probably too late, but its close).

Original mortgage had $66k of interest paid
adding $1000/mo to payment knocks the mortgage down to 102 payments and $41k of interest paid

compare this to the post I replied to (which have 25k lump sum applied, then nothing else)
Its the same interest paid ($42000 with lump sum and $41,000 by wiping out other debt first)
and with lump sum house was paid off in 136 payments and my way it was paid off in 102 payments (that is a savings of about 3 years of payments).

So 3 years of payments saved is $36,000+ normal mortgage payment+ less interest paid on all loans combined

You need to evaluate this over time, and cannot just make assesments based on interest rates. This is because the amounts financed are not close (31k vs 130k is not a close comparison).

Less risk with paying off cars (relative to house)
Less interest is paid if you pay down cars first (consider I did not add the interest paid on cars to example presented by post I replied to)

Its a slam dunk- pay off the cars first.
$36,000 more in your pocket, plus less interest paid on all accounts combined, plus higher cash flow earlier in life.
Unless there is a variable I missed, its a slam dunk- pay off the cars first.

[jpg7n16]

I am going to say this is BAD advice, and qualify this with run the numbers to be sure.

Okay yeah. Let's do that.

Please read what the OP was looking for again. He wants to save interest not cashflow. They are two totally different things.

...My interpretation of this is you paid $25,000 to save you $42,000. This is a decent return, but without a timeline you do not see these savings until payment 136 of an orginal 180 payment schedule (meaning you reduce payment period on mortgage by 44 months (4 years) with the 25k lump sum.

Without factoring in inflation, this means you spend 25k now to save a high amount of interest, but you do not see the cash flow return on this money for another 10+ years.

Yes you can save "more interest", but without a timeline, saving on interest in this 1 isolated case is not a big enough picture.

If you pay down the cars first, the interest saved will be much clearer and sooner.

No. The cashflow will be clearer and sooner if he does what you suggest.

The interest is a different factor altogether.

You seem to forget in your argument that the cars will be paid off in 2-5 years on the current path. After that point, the car payments can be applied to the mortgage anyways. You either start that process today, or in 2-5 years.

Now unlike you, I'll actually do the math before I decide if my advice is good or not.

And since he only mentions having 15k, I'll use it instead of the 25k you used. And I'll assume he only chooses between 2 options (#1 - pay down mortgage, #2 - pay down car2, then car1)

The baseline: after 1 yr
Mortgage: 12 pmts of $1,088; ending balance of $124,430 ($13,059 paid - $5,570 balance reduction = $7,489 interest paid)
Car 1: 12 pmts of $587; ending balance of $25,067 ($7,044 paid - $5,954 balance reduction = $1,090 interest paid)
Car 2: 12 pmts of $470; ending balance of $3,258 ($5,640 paid - $5,459 balance reduction = $181 interest paid)
Total Interest Paid: $8,760

Option 1 - (15k to the mortgage) = My suggestion
Mortgage: balance reduced to $115k, same payment
12 pmts of $1,088; ending balance of $108,525 ($13,059 paid - $6,475 balance reduction = $6,584 interest paid)
Car 1: 12 pmts of $587; ending balance of $25,067 ($7,044 paid - $5,954 balance reduction = $1,090 interest paid)
Car 2: 12 pmts of $470; ending balance of $3,258 ($5,640 paid - $5,459 balance reduction = $181 interest paid)
Total Interest Paid: $7,855 (interest savings of $905)

Option 2 - (15k to the cars, put car2's pmt towards mortgage) = Jim's suggestion
Mortgage: 12 pmts of $1,558; ending balance of $118,636 ($18,699 paid - $11,364 balance reduction = $7,335 interest paid)
Car 1: balance reduced to $24,739, same payment
12 pmts of $587; ending balance of $18,538 ($7,044 paid - $6,200 balance reduction = $844 interest paid)
Car 2: balance eliminated ($0 paid, $0 interest)
Total Interest Paid: $8,179 (interest savings of $581)


Using Jim's option would cost the OP $324 more in interest in the 1st year ($27 a month) which is about 35% less than what my option would do. And would not really improve cash flow, because the cash from the car is going straight to the mortgage anyways (I'll do the math for you - under both scenarios you would make $25,743 in payments towards debts) Anyone want a free $324??

And $25k would just exaggerate my method's effectiveness. You ALWAYS save the most interest by paying towards the highest tax-adjusted interest rate. Always.

Interest. Not cashflow - interest: which is what the OP was asking about.


Jim - please do the math next time BEFORE you tell everyone how "BAD" my advice is...

[jIM_Ohio]

Okay yeah. Let's do that.

Please read what the OP was looking for again. He wants to save interest not cashflow. They are two totally different things.


No. The cashflow will be clearer and sooner if he does what you suggest.

The interest is a different factor altogether.

You seem to forget in your argument that the cars will be paid off in 2-5 years on the current path. After that point, the car payments can be applied to the mortgage anyways. You either start that process today, or in 2-5 years.

Now unlike you, I'll actually do the math before I decide if my advice is good or not.

And since he only mentions having 15k, I'll use it instead of the 25k you used. And I'll assume he only chooses between 2 options (#1 - pay down mortgage, #2 - pay down car2, then car1)

The baseline: after 1 yr
Mortgage: 12 pmts of $1,088; ending balance of $124,430 ($13,059 paid - $5,570 balance reduction = $7,489 interest paid)
Car 1: 12 pmts of $587; ending balance of $25,067 ($7,044 paid - $5,954 balance reduction = $1,090 interest paid)
Car 2: 12 pmts of $470; ending balance of $3,258 ($5,640 paid - $5,459 balance reduction = $181 interest paid)
Total Interest Paid: $8,760

Option 1 - (15k to the mortgage) = My suggestion
Mortgage: balance reduced to $115k, same payment
12 pmts of $1,088; ending balance of $108,525 ($13,059 paid - $6,475 balance reduction = $6,584 interest paid)
Car 1: 12 pmts of $587; ending balance of $25,067 ($7,044 paid - $5,954 balance reduction = $1,090 interest paid)
Car 2: 12 pmts of $470; ending balance of $3,258 ($5,640 paid - $5,459 balance reduction = $181 interest paid)
Total Interest Paid: $7,855 (interest savings of $905)

Option 2 - (15k to the cars, put car2's pmt towards mortgage) = Jim's suggestion
Mortgage: 12 pmts of $1,558; ending balance of $118,636 ($18,699 paid - $11,364 balance reduction = $7,335 interest paid)
Car 1: balance reduced to $24,739, same payment
12 pmts of $587; ending balance of $18,538 ($7,044 paid - $6,200 balance reduction = $844 interest paid)
Car 2: balance eliminated ($0 paid, $0 interest)
Total Interest Paid: $8,179 (interest savings of $581)


Using Jim's option would cost the OP $324 more in interest in the 1st year ($27 a month) which is about 35% less than what my option would do. And would not really improve cash flow, because the cash from the car is going straight to the mortgage anyways (I'll do the math for you - under both scenarios you would make $25,743 in payments towards debts) Anyone want a free $324??

And $25k would just exaggerate my method's effectiveness. You ALWAYS save the most interest by paying towards the highest tax-adjusted interest rate. Always.

Interest. Not cashflow - interest: which is what the OP was asking about.


Jim - please do the math next time BEFORE you tell everyone how "BAD" my advice is...

I did the math, its in my post, and its a slam dunk (not even close) and I think you need to re-read my post and compare apples to apples. You only added interest for 1 year, and the OP won't even noticed they saved interest and saved money for another 12 years. If OP wants to save interest just this one single year (that was not his objective), then put money on mortgage.

I agree after 1 year less interest is paid if OP puts money on the house- that is because that loan is highest interest rate. However it takes a simple mind to figure that out... when you look deeper into problem, you can CLEARLY see over any period of time longer than 5-7 years that OP will pay less interest if the cars are paid off first, then snowball those loans into the house.

my point is LESS interest is paid over next 10 years if the money is used on cars first, then on house second, and that math is a slam dunk, not even close.

That has nothing to do with cash flow, the improved cash flow is a bonus on top of less interest paid.
It's important to put the interest paid on a timeline. Because its diminishing returns- do the same math you did for 10 years, and you will see my way has OP paying less interest.

In addition, you are using fuzzy math

Using Jim's option would cost the OP $324 more in interest in the 1st year ($27 a month) which is about 35% less than what my option would do. And would not really improve cash flow, because the cash from the car is going straight to the mortgage anyways (I'll do the math for you - under both scenarios you would make $25,743 in payments towards debts) Anyone want a free $324??

If payments are the same, then no way could your technique have an extra $324. NO WAY. That is because a mortgage payment is fixed, and unless OP refinances, the "savings" is not seen in the budget until mortgage is paid off. Th OP might have paid $324 less in interest 1st year, but they did not have that $324 in their pocket- because the mortgage payment is not reduced when a lump sum payment is made.

My technique had mortgage paid off sooner than your technique by 3 years and paying $1000 less interest on same mortgage. That is a slam dunk, and its not even close (that is $36,000 less paid on mortgage in those 3 years, plus the interest savings of $1000).

I will take a $37,000 savings over a $324 savings. With decisions like that, you prove very little.