Pay off second loan or enjoy tax break?

October 16, 2007 7:07 PM

Finance Filter: I have a second loan on my condo at a rate of 7.75%.. I did this to avoid PMI. I have the cash to pay it off.. 35k or so.. Is it likely a good idea to pay it off and forgo the tax breaks I'm getting on the interest, to avoid the 7.75% rate?

I'll take all responses at face value.. I'd like non-professional advice before seeking a financial adviser..

Thank you

posted by seinfeld to work & money (7 comments total)

Do the math... we can't answer that without knowing how the tax breaks work for you....
posted by HuronBob at 7:13 PM on October 16, 2007

This is a fairly straightforward calculation.

If I pay this off as scheduled, how much will this cost me? ( [cost of payments] - [savings from tax breaks] - [interest I'll earn while investing this 35k])

vs.

If I pay this off now, how much will this cost me? (35k)

You do the math.

The only big intangible factor to consider is whether you'll need some extra cash over the next few years. If you pay off the loan, you're debt-free, but you won't have 35k sitting around in case of emergencies.
posted by chrisamiller at 7:16 PM on October 16, 2007

I'm not in the same country as you but I'd expect, unless there's relevant information missing here, that the tax breaks are a fraction of the interest you're paying. e.g. If your being taxed at a rate of 30% and you get to deduct the interest paid from your taxable income, then your tax savings are equal to 30% of the interest you're paying. Paying off the loan saves you 100% of the interest.
posted by winston at 7:16 PM on October 16, 2007

oops. your > you're
posted by winston at 7:17 PM on October 16, 2007

winston, that true, but paying off the loan also costs you 100% of the return you could earn on that $35k.

I don't think this question can be answered without more numbers.
posted by Mr. President Dr. Steve Elvis America at 7:21 PM on October 16, 2007

If your primary mortgage has interest expense that exceeds the standard deduction, so that the interest on the second mortgage is 100% deductible, you could do pretty well investing the money. You'll pay taxes on your gains, but assuming you hold your investments longer than a year, you'll pay only the capital gains rate, not the regular income tax rate. Over a long period of time, you should be able to get 10-12% return, and $35,000 is enough to get free trades through brokers such as Wells Fargo so you could diversify fairly well.

If you don't have a Roth IRA and aren't excluded from contributing to one by the income limits, you could put the money there (it would take several years to get it all in) and never pay tax on the gains, while still being able to withdraw the original contribution without penalty for emergencies and stuff.

If your primary and second mortgage interest combined don't exceed the standard deduction for your filing status, then it's a tougher call. I'd probably pay it off in that situation.
posted by kindall at 7:27 PM on October 16, 2007

There is also an emotional factor in terms of how you feel about the monthly payments. If your budget is really tight, I personally would rather not have the expense than to pull money out of savings to make my monthly bills, clearly an emotional and not a rational decision.
posted by metahawk at 8:46 PM on October 16, 2007