Variable rate HELOC and snowball effect

[WCIfan]

Huge fan of WCI here -- I love the book, podcasts, recommended reading -- all of it.  Big fans of physician on FIRE too.

Please help with our scenario:

I am 4 years post-fellowship, working at academic medical center and enjoy my job.  Unfortunately, the PSLF did not make sense when I examined it as a new attending (income-based payments resulted in early payoff of loan)

Family of 6, wife works a little from home but mostly wrangles our scrum of kids...

Assets:

Savings: $548K ($95K liquid in cash/taxable account, $68K for kids college in 529s, $370K in various retirement accounts)

Salary = 420K

Bonus/side work of 90K per year

 

Expenses:

Grocery/clothing/utilities/oil and tires for my clunker (upgraded wife's car in 2017) ~ 14K per month

We max out 403b at 18K per year, 457b at 18K per year, backdoor Roths for wife and I at 11K per year, and 10K to 529s for kids per year.  University provides match plus additional contribution of about $3500 per month into 403b.  We put an additional 2K per month into a taxable retirement account.  (Investing/saving $10,500 per month total or ~25% of salary + bonus)

Try to give away 10% of income

 

Debts:

Student loans: 98K remaining at 3.25% -- paying 3000 per month toward this (had 250K in student loan debt after fellowship; just paid off biggest loan of 150K which was at 3.9% last month)

Home mortgage: 300K at 3.25% 30-year fixed

Other debt: 77K HELOC (this is a leftover from our doctor loan, intended to avoid PMI) at variable interest rate, most recently increased to 4.75% -- paying minimum payments

Auto: 32K at 0% x 5 years (just replaced wife's 11 year old car which was falling apart)

 

My question is:  Which debt should we work to eliminate next?  Should I pay off the HELOC and decrease the payments to the student loan (currently 3K per month plus any windfall)?  Or should I continue to attack the student debt until it is gone?

The HELOC is irritating because the interest is likely to rise further, but I enjoy the tax benefit as we do for the home mortgage.  The student loan debt of $98K remaining is at a fairly low rate but we receive no tax deduction for the interest.

To complicate things, we are REALLY interested in buying recreational land as a weekend getaway for our family which in our state is surprisingly cheap...1-2K per acre.  I would like to do this before our oldest child starts high school in 4.5 years.

 

 

 

 

 

 

 

[DMFA]

Imo, prob HELOC first with the variable rate.  I estimate it's probably 2.87% after tax deduction, which while that's lower than your non-deductible rate of 3.25% on your student loan, has the ability to increase above it.  Neither is wrong as long as you're making good headway on your debts while continuing to invest in equities as well.

Tax-deductible interest is *not* a tax benefit per se; it's still debt and it's still money you're losing.  Its tax deductibility just lowers the quoted interest rate by your tax bracket.  In your case, it's at a 39.6% lower interest rate than quoted.  The mortgage is in a similar vein, but given that its post-tax rate is near historical inflation rates (1.96%), I would place it last in priority.  It's generally not worth paying over the minimum on long-term debts whose rates are below inflation, like 30-year mortgages near 3% for people in tax brackets 33% or above.

You've still got quite a bit of debt, though what you do have seems appropriately structured to low rates and/or terms.  I think you'd do well not to add to that by buying vacation property; I really don't think someone with your income level and savings rate should be looking for new debts to take on, rather to eliminate the ones they have.  At your current rate you'll pay off your student debt in just under 3 years (34.2 months).  Now, if you do decide to take on that debt, you'll probably deal with it just fine anyway as long as you're earning half a million dollars a year and investing further.

[StarTrekDoc]

The current debt is really autopilot and it'll burn out in 3.5 years .

?:  public school and state school for the kids -- or Academic center funded tuition?

4kids is a huge future tap and that 529 is skinny if not supported elsewhere.

Is there a reason for the rec land vs BLM or national/state park rec?

 

 

[Craigy]

You can always just pay aggressively on both the student loan and HELOC at the same time, if you're truly torn.  With your cash on hand plus your income, both should evaporate in pretty short order.

Personally I'd be most frightened by that HELOC, and would dip into that $95k of cash/taxable account pretty heavily to wipe it out or at least cut it in half immediately.  I suppose it depends on what sort of tax hit you'll take on liquidation.

Obviously the 3.25% 30 year mortgage and the 0% car payment should be last on the list.  However the car payment is probably a sizable monthly payment so eventually paying it off would help with the snowball if snowballing works for you.

[ReFinDoc]

I don't believe interest rates are going to go very much or very fast, but what do I know.

Another wrinkle is tax reform...if Congress doubles the Standard Deduction, then mortgage/HELOC interest could become less valuable. I would wait to pay off the HELOC and see what happens. The exemptions for your kids might go away too.

The student loan interest will never be deductible.

I don't really see the need for pay off any of these low interest loans. Your income is so high that you have many options. You also have a lot of alternative places to put your money, lie 401ks, HSAs, Roth IRAs. It is not like you are going to default on these loans and have your house repossessed. What is the term of the HELOC? 20 years? Maybe start a "pay-off" taxable account. Wait for big time LTCG and pay off the HELOC at potentially 0% tax rates. Your mortgage (not the HELOC) has built-in inflation protection. Just because you pay off the mortgage/ HELOC, the other expenses (i.e. RE taxes) of owning a home don't magically disappear just because it is paid off.

[docnews]

Why are you investing in taxable accounts if you have debt that is "irritating" you? Mathematically you will be okay with taxable investment over low interest debt but it sounds like you would like to lower your risk at this time. Just fill up your tax advantaged accounts then you use further left over money (can leave already taxable account money there to avoid tax hit) towards the HELOC and student loans. Then pay off the car after the 0% runs out. As for the mortgage, you can pay it off when you have enough equities that you want some more "bonds" / low risk investment especially if you are planning on an early retirement.

If the cost of vacation land is so cheap, why not cash flow it once you finish off the HELOC and student loans?

Side note: This is a pet peeve of mine but 529s are spending / not saving. It is a charitable gift to your kid's education that can grow until needed, but it's not your money. If you have dedicated yourself to pay for their education, you could say you are reducing your future spending but its never savings for you. Maybe you could say its an investment if you going to make your kids pay for your retirement

 

[White.Beard.Doc]

I would say you are doing great overall.

It sounds like the uptrending interest rate on the HELOC is bugging you.  It will likely continue to creep up.  And the difference in interest between that and the student loan, even after taxes, is quite small.  For someone with your income, you might consider doing what is going to feel better.  Psychologically, a fixed rate is totally predictable and therefore more comfortable, variable not so much.

 

[Craigy]

ReFinDoc wrote:

 

I don’t really see the need for pay off any of these low interest loans.

Click to expand...

The reason IMO is so that you don't end up one of the too many physicians who are still paying student loans in their 50s, making a ton of money but watching half of it go out every month to service all of their debt during their entire careers.  Any new purchase is just new debt on the stack.   Sure, the term on that heloc might be 20 years and the mortgage 30 years and they'll eventually get paid off, but in 10 years they might move to a new house altogether and extend those another 30 years.

If you're doing everything right, carrying low interest debt could be smart, but for most, it just turns into a lifetime of payments.

[csciora]

DMFA: In your case, it’s at a 39.6% lower interest rate than quoted.

 

Small correction. It's lower than the quoted rate by their effective tax rate, not the maximum federal tax rate. Effective should be quite a bit lower. There's also a phaseout at their income levels along with AMT considerations, so it's not quite that easy to figure out the "real" interest rate on the mortgage and HELOC.

[DMFA]

csciora wrote:

DMFA: In your case, it’s at a 39.6% lower interest rate than quoted.

 

Small correction. It’s lower than the quoted rate by their effective tax rate, not the maximum federal tax rate. Effective should be quite a bit lower. There’s also a phaseout at their income levels along with AMT considerations, so it’s not quite that easy to figure out the “real” interest rate on the mortgage and HELOC.

Click to expand...

Yes and no.  Deductions *are* at the marginal amount, not the effective amount.  Think of it as skimming off the top.  On the other hand, I didn't account for the likelihood of AMT, which in 2017 is 26% below and 28% above $187,800 of taxable income, then it would still be that marginal amount (which is p much the same as the effective rate in AMT).

He grosses $510k, has $36k in retirement deductions, $24,300 in exemptions, prob $8,825 or so in mortgage interest, prob $6,000 or so in property tax, assuming he actually gives $50,000 to charity, can deduct half of SE tax of $1,305, so final taxable income is $384,875, putting him down into the 33% range...effective rate of 20%, yeah, looks like that's gonna be subject to AMT...which on the back-of-the-envelope, $510,000 reduced by only retirement contributions and mortgage interest brings it to $465,000 or so, above the exemption phase-out...times 0.28 minus 3756, is $126,493, so an effective tax rate of 24.8%.  That means the mortgage/HELOC interests are p much 28% discounted.  So not quite as rosy, but still not awful.

Can I recommend *not* giving to charity? [lol] It's not deductible for AMT.

[WCIfan]

Wow, thanks everyone for the responses. These are all good options. I thought I had a handle on this but the tax implications are mind-boggling.

ReFinDoc, what do you mean by " Wait for big time LTCG and pay off the HELOC at potentially 0% tax rates."

How can I do this? Would I need to purchase a tax exempt mutual fund to take advantage of the LT capital gains?

[csciora]

DMFA wrote:

Yes and no.  Deductions *are* at the marginal amount, not the effective amount.

Click to expand...

Hmmm, now you're making me think harder. My knee jerk reaction is it can't be marginal because you don't save that much. Simplifying everything, let's say there's $100K in interest deductions that drops you from the 40% marginal rate to the 30% marginal rate. That doesn't save you $40K in taxes which you'd get by applying the marginal rate to the $100K. But it also doesn't save you $30K.

It feels like the right answer is somewhere in between and really depends on all the other stuff going into the tax return. I'm *almost* positive (still before breakfast for me) that this is accurate: (a) calculate total tax due without any mortgage deduction and (b) calculate total tax due with full mortgage interest deduction (or whatever portion is applicable). The absolute dollar difference is due entirely from the interest deduction. Divide into the total interest paid to figure the percentage which almost certainly isn't marginal or effective rates. That approach has to be right.

I'll work through your example numbers later today when the left side brain decides to start participating.

Right now, I'm having deja vu about wondering whether debt reduction is really equivalent to savings or not. Is owing less the same as having more!??! ;-)

[DMFA]

csciora wrote:

DMFA wrote:

Yes and no.  Deductions *are* at the marginal amount, not the effective amount. 

Click to expand…

Hmmm, now you’re making me think harder. My knee jerk reaction is it can’t be marginal because you don’t save that much. Simplifying everything, let’s say there’s $100K in interest deductions that drops you from the 40% marginal rate to the 30% marginal rate. That doesn’t save you $40K in taxes which you’d get by applying the marginal rate to the $100K. But it also doesn’t save you $30K.

It feels like the right answer is somewhere in between and really depends on all the other stuff going into the tax return. I’m *almost* positive (still before breakfast for me) that this is accurate: (a) calculate total tax due without any mortgage deduction and (b) calculate total tax due with full mortgage interest deduction (or whatever portion is applicable). The absolute dollar difference is due entirely from the interest deduction. Divide into the total interest paid to figure the percentage which almost certainly isn’t marginal or effective rates. That approach has to be right.

I’ll work through your example numbers later today when the left side brain decides to start participating.

Right now, I’m having deja vu about wondering whether debt reduction is really equivalent to savings or not. Is owing less the same as having more!??! ????

Click to expand...

It saves you the marginal rate from the top down. When you cross brackets, it saves you the proportion of those brackets you save. So if he would have been entirely in the 39.6% bracket, it would save him that much. If he saved an equal amount of the 39.6% and 35% brackets, it would save him 37.3%. Both of those are well above the effective rate. For AMT, there's two margins: 28% and 26%, with the effective rate usually being in the low- to mid-20s.