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Home Prepayment Strategy?

Question: I figured that an additional 100.00 per month on my morgage payment will save a total of 66,000 in interest and will turn my 30 year loan into a 20 year loan. A friend of mine has a totally different money strategy and I was wondering if others agree with his thinking. His opion is as follows: Take the same 100 per month and put it into the stock market via a good stock mutual fund. He feels over the same period between tax savings and the growth of the investment that this would be higher than the 66,000 dollars. He asusmes a growth rate of min 10% per year over the same 20 yr period. Is this thinking solid or flawed. Obviously if the market does very poorly this doesnt stand up but I would figure a min of 7-8% growth over that period.

Answer: I’ve been shopping lately for a home equity line of credit. The rates I’m being quoted are in the prime (8.25%) + 2 range for 100% equity, closing costs range from $0 to FOUR! points. Assuming one is in the marginal 28% bracket (about $40,000 income), I’m calculating the effective rate like this: 10.25% * .72 = 7.38%. IOW, an equity loan at 10.25% would be effectively the same as a signature loan at 7.38% for someone in the marginal 28% bracket (1.00 – .28 = .72).

You’d have to have a ROI of better than 7.38% to make this worthwhile, OR use the loan proceeds to eliminate debt with rates higher than 7.38%. This, of course, assumes one does not have any closing costs associated with the loan. Using an equity loan to eliminate debt is, IMHO, a valid reason. Using one to invest the proceeds is a bit too risky for me.

Another thing to consider: folks often apply too much weight to the fact that equity loan interest is (usually) deductible. You’re *still* paying interest, even though it may be less than on a non-deductible loan. If you borrow at 7.38% to invest, and your ROI is 11%, you’re barely beating inflation!

If my math or reasoning is flawed, by all means issue clarifications.

BTW, can you explain more about equity loans being illegal in Texas? This must be a state law. Is this the case in any other states?

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Filed under: Home Equity Loan