Another 'what to do with lump sum' question

harriethomeownerOctober 1, 2006

We have a HELOC balance of about $55k at a rate of prime + 0 (so 8.25% right now). That makes the monthly interest amount around $380. We have been paying $750/month toward that loan, which will pay it off in about 9 years. We are going to get a lump sum of about $20,000 from selling something we own. Would it be better to put the entire amount toward the HELOC or to invest it (we were thinking of adding to our Roth IRAs, which we haven't been able to do the past 2 years, and then topping up our emergency fund by putting the rest into a 12-month CD)? I'm inclined toward the latter, with the thought that lowering the HELOC balance won't make that much difference. Yes, I know that it will cost about $14,000 in interest over the 9 years, but that's all tax deductible. It would somehow just feel better to have cash available.

My other thought is that if we could pay off the HELOC outright, it would be worth it, but because this amount of money wouldn't even cut it in half, it's not really worth it. Does that make sense?

Our primary mortgage, BTW, will be paid off in 12 years, before we are even at retirement age, if we continue without making any changes. We don't have any other debts.

Is there anything I'm not taking into consideration? Thanks for any comments.

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devorah

I agree with you, though I might put all of it into two 10k CDs with staggered maturity dates. I don't know how much ready cash you have already. If you have plenty then go ahead and fund your Roth.

    Bookmark   October 1, 2006 at 3:17PM
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aphilla

Personally I wouldn't be without a short term reserve fund. If you go this route compare CDs with short term government notes (they offer 30, 60, and 120). Yields are available here: http://www.investinginbonds.com/marketataglance.asp?catid=33. One advantage is that they are not subject to state income tax, so if you live in a state with a high income tax, there is an additional benefit.

    Bookmark   October 5, 2006 at 12:31PM
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harriethomeowner

I was looking at CD rates; the best we could do would be about 5% for 1 year. Bonds look like they are about the same. It seems like the cost of trading would cancel out the cost of taxes on the CDs, given the small amount of dividend income involved. But I am not educated about nonretirement investments; we don't have any, and I don't know how to go about setting them up or maintaining them (guess I could find out, though). I would prefer to have a year's worth of emergency funds at hand before we go that route, I think. The Roths are a pretty safe bet, so we'll definitely do that in any case.

Thanks for the input.

    Bookmark   October 5, 2006 at 1:35PM
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raee_gw

Harriet, I have to disagree with the other responses. You already have a source of emergency money in your line of credit. Although I am sure that you, as I, would hate to borrow emergency cash, over both the short and long term you will end up with more money in your pocket by paying down the loan (I think about $1700/year @ $20k x 8.5%--equal to one months income for me!). Your current interest rate is high and you cannot earn a rate to come close. The monthly payment will be reduced, or you can just pay the whole thing off faster, and redirect the money you have been gifting to the bank into your IRA. It is very smart to fund your IRA and have an emergency account, but smarter to reduce any money going out in interest first. By the way, CDs and bonds are not the best place to keep money for emergencies because of the restrictions and costs of redeeming them early. Just what I would do--good luck.

    Bookmark   October 5, 2006 at 1:58PM
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harriethomeowner

You know, raee, I'm thinking you may be right. I just did a quick calculation with a Bankrate calculator, and here's what I found:

Scenario 1: pay $750/mo, pay off loan in May 2015.
Interest paid from now until October 2009 = ~12,000
Balance in October 2009 = ~40,000

Scenario 2: pay $750/mo plus 12k in November 2006, pay off loan in December 2012.
Interest paid from now until October 2009 = ~8625
Balance in October 2009 = ~25,000

Or perhaps pay a bit more per month and keep some for the emergency fund:

Scenario 3: pay $800/mo plus 10k in November, pay off in October 2012.
Interest for 3 years = 8923, balance in 10/09 = 25,117.

The reason I used 3 years is because if we continue to save regularly, we should have more than enough to pay the balance off by that time, if not sooner.

Thanks!

    Bookmark   October 5, 2006 at 5:48PM
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joyfulguy

Hi Harriet,

You're paying 8.25%, deductible, on your HELOC.

You're talking about investing at 5% ... taxable. Which will produce what rate, after-tax?

Why do you need to worry about an emergency fund?

Your HELOC is almost certainly for a larger amount that you owe currently, so if you pay most (or all) of the $20,000. down on the loan, you'll have that much more available should you need it in the HELOC, won't you?

Keep paying at your current rate on the loan, so it'll be paid off sooner.

I can't give any advice on Roth stuff, for I know nothing about it (being a furriner).

We have retirement accounts here in Canada and most financial advisors say that every person earning employment income who's a taxpayer should use them, but some of us disagree - for reasons that relate largely to the varying tax situation that affects various kinds of income, when it's applied and the fact that every dollar of proceeds of one's retirement fund is fully taxable, on withdrawal.

By the way - maybe you should arrange a HELOC here in Canada.

I have one fully secured by securities and they recently quoted about 6.25%.

I'm waiting for a market correction to draw on it again - the market's too high, right now. And precarious.

An investment group that meets monthly that I've attended for half a dozen years or so were rather largely antsy about the market at last month's meeting.

Hope you make the decision that's wisest for you folks.

ole joyful

    Bookmark   October 6, 2006 at 4:09PM
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raee_gw

Just another thought in general-- tax deductions are usually a poor return on investment. I mean if you keep a debt going because you get a tax deduction from it, you almost always lose money overall, because the tax deduction results in way less money in your pocket than reducing the money subject to interest charges by your lender would. Sales people like to tout tax deduction as a reason to carry a debt because they know that few people will actually sit down and figure it out.

    Bookmark   October 10, 2006 at 11:05AM
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harriethomeowner

Thanks for the comments. I know that about the tax deduction thing, raee. I would never keep a debt just for that reason.

I think we are going to use the extra cash to pay down the HELOC balance and go from there. If we do have an emergency, we have alternatives, so there doesn't seem to be a good reason to keep it around and pay the extra interest "just in case."

    Bookmark   October 10, 2006 at 1:42PM
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