Calculation question, what is better to pay off overall with consideration to tax deductions…?
April 30th, 2010I am trying to decide what is best to start using my extra money to pay off…a student loan at 5.4%, an auto loan at 4.99% or a heloc at 7.75% I know student loans and heloc interest is tax deductible, but assuming these deductions don’t affect a change in bracket (tax rate) what is the calculated difference in interest saved (assuming 15% bracket) on whether to pay which of these three….(I guess I’ve always been told pay non-deductible first, but with these numbers I just don’t see how that adds up…and most importantly how do I actually calculate the real interest I’m paying on tax deductible interest so I can compare it to nondeductible rates…) thanks in advance for any help!
Replys
Your tax savings on a deductible item is 15% of the expense, so on the heloc 7.75%, you’re still paying 85% of the interest, or .85 * 7.75%, or 6.59%, out of pocket. So paying that off still saves more than pying off the auto loan. The effective interest on the school loan is 4.59 so is the lowest of the three – pay that off last.
You first need to know your tax bracket and then any ceiling on the tax deduction. Assuming your tax bracket is 20% and there is no ceiling, your actual interest rates are 4.32% on the student, the auto stays at 4.99% and the HELOC comes in at 6.4%. Given this consideration, you would pay off the HELOC first, the car second and the student loans third.
This also has the added advantage of releasing the secured loan on the house earlier while building equity for future sale. A downside is that were you to file for bankruptcy (a situation you probably aren’t near since you are talking paying extra), the student loans would most likely not be discharged and you would come out of bankruptcy still owing that debt. IN this case, you would be better off paying extra on the student loans and plan on discharging the higher balanced HELOC and auto (higher being relative to the balance reached by paying them off quicker).
No offense, but I don’t think we’re talking thousands of dollars.
Approach #1. Get rid of the loan with the smallest balance first. If all balances are high, it won’t make you feel any better and car loans ae sometimes set up as rule of 78 (no credit for early payment unless you pay the entire thing off).
Approach #2. Get rid of the loan with the highest effective interest rate. That’s the Heloc.
Approach #3. Get rid of the item that has the shortest life span.
How old is your car? Cars tend to last 10 years now before needing major repairs.
How long do you intend to stay in your home? What’s your current equity?
How long have you been out of school? Is this your loan or your child’s/spouse’s? I’m trying to figure out how you would have bought a house at all if you stll owed on student loans….
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