5 Responses

1. pharmboy

   March 31st, 2008 at 11:28 pm

   1

   we’re in the same boat. it’s 5.5% fixed five-year mortgage (60K) and consolidated student loans at 1.875% (45K).

   we paid S10,000 down on principle just the other day…on the house.

2. Jason Dragon

   April 1st, 2008 at 4:21 pm

   2

   Well just because it is going to adjust why would you assume it would adjust UPWARDS, with the current interest rates it will most likely adjust DOWNWARDS and save these people money.

   There is no reason that they should take liquid fund and put them into paying off any of these debts faster than the minimum allowed. They should separate their equity from their house (Remember the 20% rule, you should never have more than 20% of your net worth as equity in your house.) I would suggest to them that they save, the money in some sort of investment. It is easy to find investments that will do much better than the interest rates they are paying, and the interest they are paying is tax deductible.

   For most situations paying down on a house is one of the worst things they can do.

3. author

   April 1st, 2008 at 8:31 pm

   3

   if the five-year is your second mortgage, but it’s a fixed rate, I would say that paying down either one first would be fine. Neither one is killing you at this point and their both a similar amount.

4. Joe Fugly

   April 7th, 2008 at 9:48 am

   4

   Of the debts, personally I’d pay down the ARM as it has the potential to be the most volatile. Otherwise this is a simple yield arb question. Which gives the better zero risk return? Sticking the spare money somewhere with a higher return or reducing the most interest-intensive debt.

   Yes, you could up your risk exposure by investing the pay-down money in something more speculative, but then it wouldn’t be comparing apples with apples. Though owing dollars is a form of short on the currency since you are expecting it to under perform whatever else you’ve put those dollars in. Despite any short-term bounce, long-term the dollar is heading south, which means price inflation heading way, way north … that means living expenses are going to continue to take a bigger share of income.

   You have also got to bear in mind that with house prices expected to trend lower for some time, the lower your aggregate debt, if you ever get the opportunity to refinance at an lower interest rate, the better. Lending criteria are going to remain tighter for a long time. You’d need your mortgage debt to reduce at the same rate as your house price to retain the same debt-to-value ratio.

   On the flip side of the coin, is the inflation/yield arb. If a depression is avoided and the Fed’s policy of trying to achieve significant inflation is successful then the more debt you have at a low rate the better, since even the interest you earn on your money will be way higher than the net interest incurred on mortgage debt. But that is where you have a long term fix. Anything variable rate will kill you.

   Under that scenario house prices will, with the exception of the occasional fillip, under perform inflation but a net-of-relief long-term fix will also be less than inflation, let alone the interest rates of that time. Inflation cuts the debt - an average 6% compounded for 25 years makes the nominal debt worth less than a quarter in today’s money. And the higher interest rates grow your cash/savings.

   Best case scenario, it is a Credit Crunch that lingers only until sometime in 2009. Which might explain why EuroDollar June 2009 futures are pricing in a Fed Funds Rate of 2.75%. My money, though, is this is a Credit Revulsion. Which means the Great Unwinding still has a great deal of unwinding to do.

   All this said there is one purely non-financial aspect. Peace of mind. Which strategy allows you to sleep better at night?

5. Just Visiting

   April 8th, 2008 at 1:22 am

   5

   Why not save/invest it in a reasonably liquid way, then if the ARM resets too high, and your reserves are still solid, transfer the savings to pay it down then? Even if you match the current ARM rate with the investment earnings (accounting for taxes on earnings and tax deductibility of the loan interest), you’re in the plus column because you’ve retained your flexibility.

   Don’t forget to save for your next car - there should be an account building to cover the replacement cost, even if it is 5 years away. And, be sure to take full advantage of the match on your 401k.