Whenever I have a money question, I go to Cash Commons. There, users ask and answer all sorts of questions in a very helpful way. When I received this question, it seemed like a matter of opinion, so I wanted to get a few views on what the best idea way, and more importantly, why.

Matt asks:

I have both a mortgage on our house, and a home equity line of credit. The mortgage rate is fixed (4.4.%) for 15 years. The home equity is variable, right now, it is only 2.24%. I am trying to accelerate payments beyond the minimum to get out of debt more quickly.

When the home equity rate is higher than the mortgage rate, it is a no-brainer – pay the minimum on the mortgage and throw any extra money into the home equity loan.

However, when the home equity loan is lower, like now, it is a little more tricky. It may seem obvious to pay the minimum on the home equity and pay off more of the higher interest mortgage. That would be the clear choice, if I could count on not needing to tap the home equity line down the road. But, what if I anticipate some large expenses down the road, for which I would need to borrow?

If my home equity is close to the ceiling, then I won’t be able to borrow against it when I need it. No matter how much I’ve paid off my mortgage, I can’t get more from that source if I need it. So, what’s the best strategy in this situation? (And, you can ignore the issue that as the home equity gets closer to the ceiling, that hurts my credit rating a little. For the current purposes, I don’t anticipate taking out any other loans, and I pay my credit cards off each month.)

After posting this question over at Cash Commons, I got some interesting opinions.

After breaking down the situation, Mighty Bargain Hunter was a proponent of building up cash reserves, then paying down the Home Equity Line of Credit (HELOC), then the mortgage. He argues that cash in the bank buys time, even if it costs a little in the short run and that the rate on the HELOC will eventually increase to a rate higher than the mortgage, making it worth it. I agree that the cost of building up cash is low (Matt would lose less than 1/2 a percent in interest if he chooses a savings account instead of the HELOC).

Dr. Dean agrees and says that rates will rise this year so the HELOC should be the biggest concern, and the more that is paid in the short-term, the less left over there will be when the rates increase considerably. Again, a good point, and he notes that what the market will do in 2010 is his main reason for his thinking.

My take is a little big different. It’s extremely hard to know what will happen in the next year in terms of the market. At some point, interest rates will rise, and when they do, some think they will rise to a high rate in a short period of time. Whether this happens in the next year, nobody knows for sure.

The uncertainty of the situation is what makes this question difficult. Right now, Matt can make larger payments on the mortgage and effectively “earn” 4.4% on his investment. Alternatively, he can pay down the HELOC, “earn” 2.4% in the short-term, and when the interest rates rise, ”earn” more. But when will the interest rates rise to 6 or 7%?

Since it’s impossible to know, I am a proponent of taking the guaranteed return after building up some cash reserves. That way, Matt can pay off a chunk of the HELOC when the interest rates rise while only “losing” 2.4% (4.4% on the mortgage – 2.% that he can earn with a savings account such as SmartyPig), and then earn that 4.4% by paying off the mortgage. In this scenario, he doesn’t take too much risk, spreads out his “investments” slightly, and knows what kind of return he is getting.

When the interest rates on the HELOC begin to rise, it may be time to switch to making payments there because once the markets improve (whenever that may be), they may rise quickly and it will make sense to pay that down as quickly as possible. But until then, my vote is to pay the mortgage and earn a guaranteed return on your investment rather than trying to time the market to come out slightly ahead.

When do you think interest rates will rise? Do you have other advice for Matt or a different reason than the ones outlined above? Let me know in the comments!

In the personal finance community, it’s best to be out of debt. Without a question, I would rather be $20,000 richer and not have to worry about my student loans. Still, there are several advantages to being in debt:

1. Boost Your Credit Score – When you are building your way out of debt and making your car loan, student loans, and credit cards payments on time, you are improving your credit score. In the short term, being in debt may cost you in interest, but in the long run, you may save thousands by having that good credit score when you get a mortgage.

2. Tax Deductions – Student loans and mortgages are tax deductible, and can lower your overall tax bill. So in addition to owning a home and having a college education, we can take solace that the tax bill won’t be quite as high.

3. You’ll Learn Great Lessons About Personal Finance – When you don’t have to worry about your finances, you don’t worry much about managing them. Once you become responsible for your finances, you realize just how much it is costing you and try and avoid it at all costs. Those who are in debt learn quickly from the experience and are better off afterward.

I don’t advocate being in debt to collect on any of these benefits, but I include it in the reasons why I’m ok with being in debt and why I am saving instead of aggressively paying off my student loans.

Wednesday marks 6 months at my job and makes me eligible for the second half of my signing bonus. It’s nice to know that I am now a full employee and eligible for all of the benefits as everyone else. I’m actually not sure which I’m more excited about. But what should I do with the extra money? It’s not much, but it is enough that I can spend it in a variety of ways and get a lot out of it.

Decisions, Decisions, Decisions…

I can:

• Stick it all in my emergency savings and build up the $5,000 fund about 2 months sooner than expected.
• Buy a decent new HDTV for the apartment. Or clothing
• Pay down some of my debt.
• Invest it.

I am already on a regular investing plan and feel that bumping that up isn’t necessary. If I’m going to go that route, I might as well pay off some of my student loans. However, my student loans are at $23,000 and a small hit to that won’t make much difference in my life. Paying it off 5 months early doesn’t sound like much when that 5 months will happen many years from now.

I want to spend it in ways that I’ll notice, as a bonus to myself, but I don’t want to spend it all in one place and come away with nothing.

I’ve decided that I am going to use some of that money to buy some new clothes. I need a new pair of work pants and a few new shirts, which I will definitely enjoy wearing. I don’t need to dress too nicely, but I like the thought of looking clean and professional. 30% of the windfall will go towards clothing.

I also am interested in building up my emergency fund a little more. I would be very happy to know that every month, my funds can go towards other goals than simply protecting myself in case of an emergency. So I will be sticking the remaining 70% there and should be fully funded by April.

By using some of my windfall for clothing, I will be congratulating myself on a job well done while not going overboard and spending it all. I think it’s important to spend money on things that make us happy, and this gives me the clothes I want now and will likely reduce future clothing expenses in the coming months because I will already have what I’ve been looking for.

By putting the other 70% of my bonus in emergency savings, I’ll be that much closer to my goal and when I look at my accounts on Mint, I’ll be pleasantly surprised to see that the money is making a difference in my life.

If you had $1,000, $5,000, or $10,000 deposited in your bank account today, what would you do with it?

My father was gracious enough to use his Home Equity Line of Credit to pay my 6.8% student loan, and instead let me pay him for his variable HELOC loan, which currently sits at 2.4%. We decided that I would pay $100 each month toward the HELOC, and if interest rates rise, it would be beneficial for me to make higher monthly payments.

What we didn’t do well, however, is plan out the specifics of how to handle interest rate changes. We figured out how much it would be at the current rates, but didn’t have a good formula for how to make changes. I was hoping to find an easy calculator online to manage our payments and balance information, but couldn’t find anything useful. So I turned to excel. Well, to a spreadsheet in Google Docs.

Using the spreadsheet, I build a powerhouse of a loan schedule, showing how much I will owe each month at the given interest rate. When the interest rate changes, we’ll have to input it into the “Loan Information” tab, and the rest of the table will update to reflect any changes.

This exercise taught me a lot. First, it taught me a ton about excel. I love the functions, but I am now more familiar with dates and using multiple conditions. It also taught me just how much my loan is going to cost me. The interest rate is extremely low right now, and if I could lock it in, I most certainly would, but I also know that when I am ready, I will be able to make larger payments and instead of 9+ years, I may be ready to pay it off in 6 or 7. Of course it depends on the rates and whether I would be better off investing some of that money instead of paying off loans, but at a certain point, I will probably be ready to make larger monthly payments.

I think taking a step back and looking at how long you’ll be paying off your loans can put things in perspective. Credit card debt obviously has the highest cost, but when you realize that you’ll be paying for your car for the next 7 or 8 years, maybe you’ll think twice about whether it’s worth it or whether you’d rather have some of that money (plus all the interest you’ll be giving away) for other things over those years.

Here is a link so you can see the formulas behind the numbers: Student Loan Schedule.

Plese feel free to take a look, double click on the cells to view the formuals behind them. I’d be happy to explain how I got some of the numbers and how I did a few of the crazy formulas.