14

So I have roughly $5000 in student loans at 5% and about $65000 on my mortgage at 3.875% (5/1ARM). Should I put extra payments towards the student loan or the mortgage?

5% is higher, so if it's really a matter of playing off the higher interest rate that would be it, but it seems like the mortgage is a lot more "top-heavy" (not sure of the proper term) with most of the interest in the beginning and principle later on, so payments early on would have a bigger effect than later on.

Edit (originally a comment but felt it should be part of the question):
Paying the highest interest first seems to make the most intuitive sense, and that's what I hear the most, however when I plug in to interest calculators, it shows that on the 5% student loan I'll be paying $1000 in interest making min payments, so hypothetically if I pay that off right now in one lump sum I'd be saving about $1000. On the other hand, if I instead take that amount of put it towards my mortgage, the calculator for that shows I'd save $10,000 in interest over min payment (over the lifetime of the loan).

Am I missing something?

David Ly
  • 388
  • 2
  • 10

8 Answers8

15

Pay off the highest rate debt. Interest on both are charged on the balance owed, nothing more complicated than that. There are those who would call a mortgage "front loaded" but that's nonsense. Of course most of the payment is interest at the beginning because the debt is higher and you start with a 30 year term. The fastest way to pay off multiple debts is always from highest rate first and then the next and so on.

JoeTaxpayer
  • 172,694
  • 34
  • 299
  • 561
6

Pay off the Highest interest loan rate first. You must be doing something funky with how long your terms are... If you give a bit more info about your loan's such as the term and how much extra you have right now to spend it could be explained in detail why that would be the better choice using your numbers. You have to make sure when you are analyzing your different loan options that you make sure you are comparing apples to apples. IE make sure that you are either comparing the present value, future value or amortization payments...

EDIT:

using some of your numbers lets say you have 5000 dollars in your pocket you have 3 options. excel makes these calculations easier...

Do nothing:

in 80 months your Student Loan will be payed in full and you will have 54676.08 owing on your mortgage and 5000 in your pocket(assuming no bank interest)

for mortgage:

FV(3.875/100/12,80,-323.2,65000)

Pay off Student loan and allocate Student loans amortization to Mortgage: in 80 months you will have $47,910.65 owing on mortgage and student loan will be paid in full

For mortgage:

FV(3.875/100/12,80,-397.45,65000)

Pay 5000 on Mortgage:

in 80 months student loan will be paid in full and you will have $48,204.92 owing on mortgage

For mortgage:

FV(3.875/100/12,80,-323.2,60000)
Rick
  • 208
  • 2
  • 9
6

As other's have said, paying off the student loan first makes the most sense because of

  • the higher interest rate
  • the unsecured debt
  • it cannot be wiped out by bankruptcy

That said, are you planning on staying in your house for a particularly long time? If so, refinancing your mortgage into a fixed-rate loan might be the best use of your money long term. Not sure how much time is left on your 5/1 ARM before the rate starts to float, but if rates rise, your mortgage could quickly become more expensive than your student loan.

Snekse
  • 161
  • 1
  • 4
2

One other factor to consider is that Mortgage debt can be wiped out in a bankruptcy, but student loan debt can not.

Financially it is simple math to figure out which one makes more sense to pay off based on the total expenditures on interest minus tax savings from deductible mortgage interest. However, in terms of risk it might be best to pay off the student loans first.

JohnFx
  • 53,876
  • 13
  • 137
  • 250
1

I would pay off the student loans first because they are unsecured. Mortgage debt is against an appreciating asset and is therefore "better" than unsecured debt. I recommend you pay both off, but start with the unsecured student loans.

Alex B
  • 17,394
  • 11
  • 58
  • 108
1

Pay the the smallest balance first. The sooner you pay that off, the sooner you can pay more on the mortgage.

duffbeer703
  • 30,455
  • 54
  • 101
1

I think the discrepancy you are seeing is in the detail of what happens once you pay off your student loan. If you take your monthly payment for your student loan, and apply that to your mortgage once the student loan is payed off, paying the highest interest loan will cone out ahead.

If, on the other hand, you take your student loan payment and do something else with it (not pay down your mortgage), you would be better off paying on your mortgage. Say you have $1000 to put towards either loan, and there is 5 years to pay on the student loan, and 25 years to pay on the mortgage. By paying on the student loan you are, roughly, saving 5 years of 5% interest on that $1000. By paying on the mortgage, you are saving 25 years of 3% interest.

KeithB
  • 5,005
  • 24
  • 29
0

Look at my answer here, and then calculate again. If you keep on saving and keep on paying off your highest interest rate loan, you'll be 'making' money.

Also look at this answer here for saving or paying back.

Basically, you should always calculate whether the money you have is better 'spend' in a savings account or as a return payment to your loan. Always tackle the highest interest loan first.

My 0,02€

Community
  • 1
GUI Junkie
  • 2,459
  • 1
  • 19
  • 24