Author Topic: Which Debt to Pay Off First (Snowball vs Amortization)?  (Read 2867 times)

Thegoblinchief

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Which Debt to Pay Off First (Snowball vs Amortization)?
« on: December 19, 2013, 11:43:04 AM »
I've learned a lot about budget optimization reading MMM and the case studies here in the forum but I have a debt question. Here are our liabilities:

Mortgage: $106,800 left @ 6.5%

Student Loan (me, undergrad): $4,500 @0.1%

Student Loan (me, grad): $13,668 @6.5%

Student Loan (wife, undergrad): $3,180 @0.1%

Student Loan (wife, grad): $27,400 @6.5%

Same-as-cash loan for house repair: $10,900 (16.5% accrues, but not if paid before March 2015

Obviously our first goal is knocking out the same-as-cash loan, but with the other loans, should I attack the high-interest student loans first (snowball) or the mortgage?

I get that the smaller principals, when killed, will add to cashflow, but the mortgage amortization is a lot more weighted to interest. The smaller grad loan (mine) has 6ish years left, my wife's has 8 years left, but the mortgage has 23 years to go. My thinking is that paying principal on the mortgage nets a greater effect, even though the rates are the same.

Thoughts? Appreciate any feedback!

PS: A second factor is that we're underwater on the house by roughly $30K at this point, so if interest rates are still low by the time we recover positive equity (who knows?) we could refi. We're unfortunately not eligible for HARP, as our loans aren't backed by Fannie/Freddie.

If it's at all relevant, our credit is excellent (high 700s last I checked).

sherr

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Re: Which Debt to Pay Off First (Snowball vs Amortization)?
« Reply #1 on: December 19, 2013, 12:10:41 PM »
I get that the smaller principals, when killed, will add to cashflow, but the mortgage amortization is a lot more weighted to interest. The smaller grad loan (mine) has 6ish years left, my wife's has 8 years left, but the mortgage has 23 years to go. My thinking is that paying principal on the mortgage nets a greater effect, even though the rates are the same.

No, if the rates are the same then the loans are equivalent. Your mortgage amortization is a lot more weighted to interest because it's a 30 year loan and the student loans are a lot shorter of a term then that. But that's irrelevant to how much money they're costing you; you can pay off your 6.5% loans in any order you want and you'll end up having paid exactly the same amount of money.

So since all other things are equal, pay off the 6.5% student loans first, starting with the smaller one so you get the increased cash flow sooner. And be sure you pay off the house repair loan before the interest starts accruing. I don't know about your particular loan, but the way a lot of those work is that as soon as you pass March 2015 you owe the 16.5% interest since you've first had the loan, aka they back-charge you interest. Not what you want, especially at 16.5%.
« Last Edit: December 19, 2013, 12:14:50 PM by sherr »

sherr

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Re: Which Debt to Pay Off First (Snowball vs Amortization)?
« Reply #2 on: December 19, 2013, 12:25:22 PM »
Having thought for a few seconds longer, I've further considered what you said about potentially refinancing the home mortgage. My previous answer was correct assuming that the loans were locked in. If refinancing is possible I think the answer in that case comes down to how quickly you'll be able to reach positive equity, or preferably 80% equity. If the answer is that you'll be able to get there in a year or two then it's up to you, but that might be worth trying for. It depends on if you'll be able to get a loan too, I think a lot of lenders here in NC are not interested in writing < $100k mortgages.

So assuming no refinancing I'd say the order should be:
6.5% student loan $13,668
6.5% student loan $27,400
16.5% home repair loan (move up as necessary to completely pay off before they start charging interest)
6.5% mortgage
other loans

If refinancing in the next couple of years is a possibility then modify that by putting the mortgage at the top until you can refinance to a better rate, then after the refinance reorder as above. If you decide to go this route you should still make sure you pay off the home repair loan before March 2015.

Thegoblinchief

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Re: Which Debt to Pay Off First (Snowball vs Amortization)?
« Reply #3 on: December 19, 2013, 12:34:03 PM »
@sherr - Thanks for the input!

The same-as-cash loan is our first priority. We have 17 months still but getting that kind of cash is hard for us even with a very strict budget. I'm hoping to kill it in 12 months. And yes, the interest would accrue from day 1 if we missed even a penny by the deadline.

After that, I'll probably tackle the student loans, then, since getting the home loan low enough to refi would take us ~4-5 years, since we're currently at about +$10-$15K cashflow annually right now, depending on bonuses and commissions. By that time, interest rates will have probably crept up over 5%, I gotta imagine.

Exflyboy

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Re: Which Debt to Pay Off First (Snowball vs Amortization)?
« Reply #4 on: December 19, 2013, 01:49:59 PM »
Yes your right.. Make damn sure (i.e have a wide margin of error for financial disasters along the way) you have the 10900 bucks sitting in case ready to pay off a month before the deadline!!

That means save at max possible rate and if you have it in 3 months, leave it sat in your bank account or in a CD that matures a month before.. You cannot miss that date.

Then the student loans (after tax income I assume)

Then the mortgage.

Then save all that income you are not spending in ETF's or similar.

Frank