Please help me decide what to pay off first

[atxer]

Hey guys,
This is a great forum and love all the saving advice dispelled here. My balances are as below and I'd like to know the order in which I should/should not payoff my debt.

Primary Residence - $305k - 3.5% (started in Jan 2013, 30yr term)
Second Lien - $14k - 7% (10yr balloon)
Rental Property - $73k - 4.85% ($100k equity. Bought in 09. 30yr term)
Car 1 - $10k - 1.8%
Car 2 - $10k - 1.8%
HELOC - $41k - 2.75%

Cash - $15k
My annual income is $125k before taxes.

So what items should I pay off first?

Thanks!
atxer

[disneysteve]

Primary Residence - $305k - 3.5% (started in Jan 2013, 30yr term)
Second Lien - $14k - 7% (10yr balloon)
Rental Property - $73k - 4.85% ($100k equity. Bought in 09. 30yr term)
Car 1 - $10k - 1.8%
Car 2 - $10k - 1.8%
HELOC - $41k - 2.75%

My annual income is $125k before taxes.

So what items should I pay off first?

Welcome. Is the rental property self-supporting? In other words, is the rent collected covering all of your costs?

I'd focus on the 7% second mortgage. That's a ridiculous rate. Considering all of your other rates, you must have pretty decent credit. Knock out that 14K as soon as possible.

What are your total monthly expenses and what's your take home pay?

[atxer]

Hi Steve,
Thanks for the quick reply!

Yes, the rental is self-sustaining as of now. Our monthly expenses are around $6.5k which also includes primary residence mortgage. Take-home salary + rental income averages around $8.5k-9k/month.

I'm torn between paying off the $14k 2nd lien or using the $14k cash towards the $73k mortgage. As of now, the $14k lien has about $50/month interest. Compare that to about $300 on the mortgage. However, that might take a few years to completely pay off though ($73k).

[~bs]

mortgage interest on a rental is fully deductible on the schedule E. primary residence is also deductible (if you're over the standard deduction). I'd also focus on the second lien first. Even if that's deductible, the rate is double what you're paying on the other loans, so it's still more costly to keep.

After you take out the 7% loan, I'd work from smallest balance to largest in paying off the loans. Each loan you knock out frees up additional money monthly.

[disneysteve]

As of now, the $14k lien has about $50/month interest. Compare that to about $300 on the mortgage.

You are doing your math wrong. Don't look at the absolute amount being paid. Look only at the interest rate. 7% is more than 3.5%. 7% is costing you twice as much per dollar as 3.5%.

Pay off your debts in order from highest interest rate to lowest interest rate. HOWEVER, be sure to look at the effective rate including the tax deduction, not just the base rate. So if your mortgage is at 3.5% and you get a 25% tax deduction, your effective interest rate is only 2.625%

[atxer]

Steve,
I agree with you. Dollar per dollar, of course the higher interest one would make a bigger dent. Doesn't that depend on the principals though?

The way both loans are setup is different. The 73k is 30yr fixed which means most of the interest would get collected in the first few years. The 14k one has a balloon payment at the end of a 10 yr term which means I'm paying mostly interest but its a nominal amount spread over the term of the loan.

My plan is to pay these both off within 5 years. So I'd like to gauge the impact of paying down bigger chunks of principal on the 30 yr one Vs the 10 yr one so as to minimize upfront interest. Am I making sense?

[Petunia 100]

Steve,
I agree with you. Dollar per dollar, of course the higher interest one would make a bigger dent. Doesn't that depend on the principals though?

The way both loans are setup is different. The 73k is 30yr fixed which means most of the interest would get collected in the first few years. The 14k one has a balloon payment at the end of a 10 yr term which means I'm paying mostly interest but its a nominal amount spread over the term of the loan.

My plan is to pay these both off within 5 years. So I'd like to gauge the impact of paying down bigger chunks of principal on the 30 yr one Vs the 10 yr one so as to minimize upfront interest. Am I making sense?

You gauge the impact by comparing the interest rates. Each dollar of debt at 3.5% costs you 3.5 cents per year. Each dollar of debt at 7% costs you 7 cents per year. Since 7 cents is more than 3.5 cents, you want to focus on the 7% debt first.

The principal is irrelevant. The balloon payment is irrelevant. The length of time remaining is irrelevant. When determining what to prepay first in order to save the most interest, the only relevant fact is the effective interest rate.

[atxer]

Hypothetically, let's say I can pay-off both the loans (73+14) in 5 years.

In 5 years,
L1: $73k @ 4.85% 30yr-fixed would result in an interest total of ~$17240.
L2: $14k @ 7% 10yr-fixed would result in an interest total of ~$4000.

Now, suppose I get an annual bonus of $10k. If I use the bonus towards L2, my interest savings would be ~$2900 in 5 yrs and the loan would be paid-ff. On the other hand, if I use it towards L1 without paying additional principal on L2, my interest savings in 5 years would be ~$5000. $5000-$4000 (interest on L2) = $1000 savings

Am I doing this right?

[atxer]

Each dollar of debt at 3.5% costs you 3.5 cents per year. Each dollar of debt at 7% costs you 7 cents per year.

Are you sure about this?

[Petunia 100]

Hypothetically, let's say I can pay-off both the loans (73+14) in 5 years.

In 5 years,
L1: $73k @ 4.85% 30yr-fixed would result in an interest total of ~$17240.
L2: $14k @ 7% 10yr-fixed would result in an interest total of ~$4000.

Now, suppose I get an annual bonus of $10k. If I use the bonus towards L2, my interest savings would be ~$2900 in 5 yrs and the loan would be paid-ff. On the other hand, if I use it towards L1 without paying additional principal on L2, my interest savings in 5 years would be ~$5000. $5000-$4000 (interest on L2) = $1000 savings

Am I doing this right?

No. You're ignoring the fact that L2 would be paid in full long before the 5 years was up. Bankrate's amortization calculator says if I have a 14k loan at 7% amortized over 10 years and I make a one-time 10k extra principal payment, I only have 27 more payments to go.

You want to compare apples to apples. If you were to pay the 10k to L1, you would continue making minimum payments on both for the full 5 years. So if you were to pay 10k to L2, when it is paid in full you take the minimum payment and apply it to L1 each month for the remainder of the 5 years.

[Petunia 100]

Are you sure about this?

Yes.

[Petunia 100]

I just set up both loan amortizations on a spreadsheet.

According to the Bankrate amortization calculator, the minimum payments on L1 and L2 are 385.22 and 162.55, respectively. Between the two, the minimum amount is $547.77 per month.

If you pay nothing extra whatsoever on either loan, and make only the minimum payments ($547.77 in total per month). In 5 years:
- Paid $17,003.93 of interest on L1, balance remaining is $66,890.73.
- Paid $3,962.32 of interest on L2, balance remaining is $8,209.32.
- Total interest paid is $20,966.25.

Now suppose you make a one-time 10k extra principal payment on L1 on the day the first payment is due.
You continue to pay a total of $547.77 per month. In 5 years:
- Paid $14,317.13 of interest on L1, balance remaining is $54,203.93.
- Paid $3,962.32 of interest on L2, balance remaining is $8,209.32.
- Total interest paid is $18,279.45.

Now suppose you make a one-time 10k extra principal payment on L2 on the day the first payment is due. When L2 is paid in full, you take the minimum payment of 162.55 and apply it to L1. In this way, you continue to pay $547.77 per month for the entire 5 years. In 5 years:
-Paid $16,643.44 of interest on L1, balance remaining is $61,175.76.
-Paid $398.52 of interest on L2, loan is paid in full.
-Total interest paid is $17,041.96.

[atxer]

I just set up both loan amortizations on a spreadsheet.

According to the Bankrate amortization calculator, the minimum payments on L1 and L2 are 385.22 and 162.55, respectively. Between the two, the minimum amount is $547.77 per month.
.

Thanks a bunch for taking the time to elucidate. Now, if I pay 10k every year towards L1 starting May 2014, how would the numbers look?

[Petunia 100]

Thanks a bunch for taking the time to elucidate. Now, if I pay 10k every year towards L1 starting May 2014, how would the numbers look?

I love to play "what if" with my mortgage. Do you know how to set yours up on a spreadsheet? It isn't hard to do, and it really can be hours of fun.

I am writing this from my laptop. I have Starter Excel 2010. I will be glad to email the spreadsheet I made to you if you like. Just send me a PM.

On to your question, if we assume June 1, 2013 is payment #1, then your first 10k additional payment happens on payment #12. If you continue paying just the minimum payment each month, except for the additional 10k every 12 months, you will make your last payment May 2019. It just happens to occur on the month you make the additional 10k payment. However, your balance (with accrued interest) on that month will be $7916.17.

[MaraJadeC]

Hello, I'm new here and it has been fun reading the comments. You guys are thorough, I'll keep reading on and pick up ideas from you.

Thanks guys!