Use tax return on home or car loan?

I’m planning on using my tax return to repay a portion of my two large debts, the home or truck. It will obviously only be about a payments worth or maybe two on the truck.

The home is a 30 year fixed at 4%

The truck is a 6 year at 5.5%

Only been paying on both about 4-6 months

I’m leaning towards putting it all towards the truck, since it has the highest interest, is there a good way to figure it out for savings in the long term?

Clearly, it will have the greatest impact on the mortgage, but only over a relatively long time. It might save you 4-5X the amount over 25 years. The gain will be substantial but very long term.

If you’re going to be keeping the truck well past the loan term, you are better off paying it all towards the truck loan, because you will be able to drop those payments from your load that much more quickly. The gain will be less in the long run but much more significant to your short-term financial situation. (You could turn and put those car payments on the house after that, for example, multiplying the leverage.)

Yes, I am keeping the truck til the wheels fall off haha

I was thinking of what you said, use the extra on the house once the truck is done

I’m assuming you’re talking about the refund, not the return.

Pay off the higher interest loan. Do you itemize your deductions? If so, that reinforces putting the money toward the truck.

Then, adjust your withholdings so that you can pay more toward debt NOW rather than waiting an entire year for the government to send back the money you overpaid.

Consumer-debt interest hasn’t been deductible for nigh on 30 years. I am not sure how an extra mortgage payment would be accounted, but it may be considered principal repayment (not deductible).

Does your house have PMI?

This is why these things get a bit complex for many people. If the OP pays down the truck early, then later he/she will have more money that then can be applied to the mortgage. So the long term impact is better paying off the higher interest loan sooner.

But this assumes that the OP will understand the extra money left over when the truck is paid off should go to the mortgage, etc.

One complicating factor is that interest on the mortgage is deductible while interest on the truck isn’t. So direct comparison of just interest rates doesn’t work. The marginal tax bracket has to be factored in. (Assuming itemized deductions.)

Doing what you suggest in your second paragraph will end up saving him the most money down the line.

**Deereman: **Put the payment into the car, and calculate how much it saves you in both interest and payments you don’t have to make. Once you pay off the car, you put those payments into your mortgage. (I’d also put the payments you make every month into the mortgage after that, since you’ll have become accustomed to an income where you have to set aside $400/month or so for a car payment. It’ll significantly reduce the amount of interest you pay down the line.)

If it were me, I would pay it toward the truck. It might have the greater long-term financial impact going toward the mortgage, but still, for me, I would rather have one fewer bill, and I could do that by paying the truck off faster.

The problem with this scheme is that it assumes a level of financial responsibility lacking in about 99% of the population. :slight_smile:

In any case, putting the money against the truck loan is almost certainly the right move.

I think what Ruken is thinking is that making the extra payment will reduce the interest paid on that loan. Since the consumer loan (the truck) isn’t deductible anyway, nothing changes on your tax return by reducing the interest you pay on that loan. The interest on the mortgage is deductible, so reducing your mortgage interest will be slightly offset by the lost benefit of the tax deduction.

And this highlights what the OP should really focus on: total after-tax cost of debt. The truck loan is 5.5% before and after tax. The mortgage is 4% before tax, but only 3% after tax (assuming a 25% tax bracket). We could say, then, that the after-tax savings of paying off the auto loan first is 6% of the amount paid per year, and a marginal after-tax savings of 2.5% compared to paying on the mortgage.

It’s worth checking to make sure that both rates are fixed. If one has a variable rate or a balloon payment, that might be a more important factor than the present interest values.

I think you misunderstand.

If he itemizes his deduction, he can deduct his mortgage payments, but not his auto payments. That makes the effective rate on the mortgage less than 4%, which means it’s even more of an obvious choice to pay off the truck first.

This was intended to be a general statement, not actually applicable in this case where everything falls the right way for mortgage interest being lower. Sorry.

One way to drive the point home is to examine what happens to a 30 year mortgage when you shovel an extra $400/month into paying off the principle.

This is a fun little toy.
$200,000 loan at 4% for 30 years.

Payment of $954/month pays it off in 30 years – 2044
Total payments = $343,440

(assuming we’re repurposing a $400 car payment in the budget)
Payment of $1,354 /month pays it off in 17 years – 2031
Total payments = $276,216

Effective savings is $343,440 - $276,216 = $67,224
And that’s not to mention a huge jump in monthly cash flow when the house is paid off.

Yes. I have no idea what AB is going on about.

The perception is mutual - your statement about itemizing deductions makes almost no sense, for precisely the reasons I stated.

The truck loan interest is not deductible.

A lump payment on a mortgage almost always goes to the principal, meaning it’s not deductible either.

Only in the narrow and already-discussed case of reducing the total interest cost over the life - and that’s life, not a few years - of the mortgage does applying the payment to the mortgage have significant financial value. Making a larger proportional move to pay off the truck, eliminate that interest cost, and (in theory) releasing funds to continue to apply to the mortgage makes by far the most sense over all… but little of it has any relationship to itemized deductions.

I would like to agree with this. I was failing to explain to my mom the other day that it doesn’t help her to have ‘saved’ the money after her car is paid down, unless she puts that money toward paying something else off instead of going shopping.

That said, whenever I pay something off, I do take a smidge of that money and route it to my ‘fun money’ account as a short term reward system, instead of rolling all of it into the next thing. I at least know I have no willpower.

Automatic payments and account routing are also a godsend for weak minds like mine who get distracted by shiny things.

Eta that most fiancial advisors say to pay smaller items first so you can feel like you’re accomplishing something. Less finance, more psychology.

You can send it to me. I’ll be glad to take care of this little problem.

(My refund will be going toward my new roof)

StG

Do you have an outstanding balance on a credit card? That should be first.

After that I’d put it on the mortgage. While the interest rate may be lower on it, the interest payment is front loaded on such loans. Since you just started paying on it recently, I bet about 75% of your payment goes to interest. Paying down the principal now will save you a lot of money in the long run.