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AV8controller · Jul 26, 2010, 01:26 PM

I have saved up enough money to pay off my 2nd mortgage loan. I'm paying 7.75% on an interest only loan of $34,000... ($220/month). Is it better to pay off the loan or have that money in Savings. If I get the approx $2600/year in interest back with taxes, then it really doesn't matter how much of my monthly payments are only going towards interest right? I am around the 25/28% tax bracket. Is it worth it to pay off the loan or keep the money for a rainy day?
Thank you!

ebaines · Jul 26, 2010, 02:18 PM

For every $100 you reduce your mortgage principal by, you save $7.75 per year in interest. The alternative is to keep the money in savings and earn perhaps 3% or so (if you're lucky). Hence the better financial choice is to use your savings to reduce your princiipal. Your tax bracket doesn't really come into the equation - as long as your mortgage interest rate is higher than what you can earn in investments, it's best to pay down the loan. It will also help improve your overall redit score. However, the first rule of financial planning is to ensure you have enough in savings to cushion any financial hiccups, such as unplanned emergency expenses or loss of job. A good rule of thumb is that you should have several months of salary available to you "just in case" in a safe and hiighly liquid investment such as a savings account. So if paying off your mortgage will wipe out your savings, that's not such a good idea. If this is the case perhaps you can go part way - such as paying off $15K and keeping the remaining $19K in savings.

AV8controller · Jul 26, 2010, 02:37 PM

So of the $2600/yr I pay in interest, how much can I expect back during tax time? If the amount is comparable then why not just keep paying the interest, I'll eventually get most of it back.

ebaines · Jul 26, 2010, 02:47 PM

Assuming you're in a 25% tax bracket, the after-tax cost to you of $2600/yr in interest payments is 75% x $2600 = $1950. You pay $2600 to the mortgage company and get a $650 break from Uncle Sam.

If you keep the money in a 3% taxable account your after tax return is 3% x $34000 x 75% = $765 (you get $1020 from the bank in income and pay $255 in additoinal taxes, netting you $765).

So you can see you're better off paying down the loan.