3.99% APR or Tax Deductible HLOC/Student Loan?

Factual Questions
1

I am in a quandry over this:

I can take $10,000 on a 3.99% APR credit card and pay off my student loan and part of my HLOC (Home Equity Line of Credit). The 3.99% will last until the balance is paid off. I figure this will take 3 years paying about 300 a month and then an extra payment to my remaining HLOC balance. This option will cost $75.00 to access this rate (using the check provided)

BUT–The HLOC and Student loans are tax-deductions!

Both the HLOC and the loan are about 7.5-8% interest, which is double the interest of the credit card offer. But they are tax-deductions so I am unclear on what that would do for the higher rate vs the lower rate with no deduction potential…

So, having been an English Major, I am unsure as to what option to take! Any advice on what option would be best?

2

Maxing out your credit card will kill your credit, unless that’s the only one you’re carrying a balance on and you have 12 others just like it. Also, keeping on-time payments on your other debt reflects well on your credit report.

3

Well, I have a home depot card for my furnace that is interest free for a year and my Chase card that carries a balance on it as it is interest free, too. I was using the extra money to pay down the HLOC. Basically, our credit rating is good, we don’t pay interest on anything except the HLOC and the student loan.

The HLOC is going to take some time to pay off. We had to put a new roof and a few months of unemployment on it. Now we are a 1 income household since the birth of our son so I am trying to cut corners for the 2 years I will be jobless. If I was still working, we would be debt-free in a year, but since that is not the case, I am trying to pay as little interest as possible.

4

Let’s not drop letters out of our acronyms. It’s usually referred to as a “HELOC”.

5

Ignoring what it may or may not do to your credit score:

Since the interest you pay on those debts is tax-deductible, you need to need to know your marginal tax rate to get the full idea of what that interest is costing you. See this IRS link for the rates for 2006. Choose the % amount next to your total taxable income. I’m going to use 25% for an example.

I’m going to make a couple of assumptions:

  • You will pay the same amount of principal each year with either loan
  • You will pay off the loan in 1 year
    These assumptions will make the calculations easier. The amount of time it takes you to pay off the loan will change the numbers, but not the concept. If you pay a different amount to principal with the credit card than with the HELOC/Stu Loan, this will change things considerably.

For the Heloc/Stu Loan, if you paid off the 10,000 loan in 1 year, you would have paid about $400 in interest (10K*.08 / 2 and i’m probably fudging the numbers a bit … this is just for illustration, I’m not worrying about capitalization of interest, etc.) Since that $400 is tax deductible, you’ll pay $100 less in tax this year (400*.25) than you would normally. So, all told, this loan is costing you $300 for the year.

With the credit card, if you paid off the 10,000 balance in 1 year, you would have paid about $200 in interest. (10K*.04 /2)

$200 < $300, so the credit card works out better for you.

Using this concept, I would look up financial calculators on the web that will tell you exactly how much interest you will pay for each loan, based on the interest rate, the payments you will make, and how long it will take you to pay the loan off (these are not easy pen-and-paper calculations, so use something like this). After you have an idea of the total interest you will pay on the HELOC/Stu Loans, subtract the amount of your estimated tax savings (interest*tax rate) from the total interest for those loans. If that adjusted amount is more than the amount of interest you would pay on the credit card, then the credit card is the better choice, if the adjusted amount is less than the total interest you’d pay on a credit card, then sticking with the loans you have is the better choice.

YMMV, I am not a tax professional nor a financial advisor.

6

Some things to watch out for if you do the CC thing:

1 - normally those low percentages will be paid first, meaning if you borrow $10,000 at 3.9% then charge a candybar at for $1 then you pay lets say $300.00 when the month’s up next month you will see something like:
Balance $10,001, paid 300, remaining:
$9700 at $3.9% and $1 at 21.99%

Now that $1 you can not pay off till the remaining balance is paid off at the lower interest rates. This may also include interest on fees ($75 you mentioned) and interest on interest.

The other thing I have heard with Cap One only is that they will post your high balance as your credit limit on your credit report. So it shows basicall no available credit - it appears like you have maxed out that card, and your credit score takes a hit, perventing you from getting other sweet offers from other CC’s. If it is cap one I would suggest paying back a substatial amount fast so your revolving balence is lower then your credit limit (which again for cap one is your high balence)

7

A home equity line of credit, last time I checked, was only tax-deductible IF USED TO PAY FOR HOME IMPROVEMENTS. I’m not a tax attorney, CPA, bookkeeper or Enrolled Agent, so I could be missing something, but I’d be afraid of being accused of tax fraud if I deducted interested on the HELOC you’re discussing.
Consult a tax professional or relevant statute before writing that off!

8

A lot of this answer depends on how much you make and your income. Personal income tax isn’t my forte, but you have to look at the nature of the deductions.

I believe the HELOC is deducted against your income, thus reducing your AGI. I know for a fact from personal experience that if you make too much money, you won’t be able to deduct your interest. I’m sure someone will better explain the tax consequences of a HELOC.

Once you have this savings number figured out, you have to compare that against the total cost of the loan. That’s easy, just do simple appreciation over the course of the loan.

Since I don’t own a house, and I don’t qualify for student loan interest deduction, the 3.99% is better for me. I believe someone mentioned this already, but since I was in a meeting for the last 4 hrs, I will add that you shouldn’t charge any additional money to that credit card because many card companies state that they will apply payments to the larger APRs first.