Pay Off Car Loans Or Mortgage First?

Added August 20, 2004 by Ilyce R. Glink

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Summary: Should I pay off my house loan or should I pay off my other debts first? If you come into some extra cash, first check if you own any taxes on the cash. Then you should pay off the non-deductible debts first, then take the savings from paying off those loans and apply it to other debts like a mortgage. If you come into some extra cash, first check if you own any taxes on the cash.

Q: We are selling some property in the United Kingdom and will be receiving around $165,000.

We have a loan at 8 percent in the amount of $25,000 and we owe around $19,000 on our truck at 5.5 percent. Our mortgage is for $260,000 and it is financed with a 7-year balloon at 4.75 percent. We would like to have most of our mortgage paid off by 2010, which is when it comes due.

What do we do with the cash we're getting from England? Would it be better to pay off these loans and put less on the house, or put all of the money toward paying off the mortgage, minus what we need to pay taxes and a bit of savings.

A: I don't know how much you'll owe in taxes on the house sale in England, but you're in a nice position to be completely debt-free within 10 years.

Let's start with taxes and assume the home you sold was an investment property. If you held the investment property for a year, you'd owe the IRS 15 percent on the net profit (sales price minus the cost of purchase, cost of improvements and the cost of sale).

On $165,000, you'll owe about $25,000 in long-term capital gains tax. That leaves you with $140,000 in cash.

Next, let's tackle your two smaller debts. I don't know what the $25,000 loan at 8 percent is all about, but I'm assuming it's a car, so the interest cost is not deductible on your federal income tax return. Your truck is not deductible either, and that's another $19,000. Together, that's $45,000 in debt eliminated, so you're left with $95,000 of your original $165,000.

If you take the $95,000 and use $85,000 to pay down your $260,000 mortgage, you'll only have $175,000 left.

Now, let's look at how quickly you can pay that off. I've guessed that each of your car and truck payments were 60-month loans. If you take the savings each month from your car and truck loans, you should be saving somewhere in the neighborhood of $860 per month.

If you apply that to the $175,000 mortgage you have left, and if the interest rate stays at 4.75 percent for the entire seven years, you should be able to pay off the mortgage entirely in 11 years, according to the amortization calculator at Eloan.com.

If you wish to pay the mortgage off sooner, all you have to do is find additional savings in your budget and use that to pay down the loan more quickly.

Here's another thought: If the home you owned in England was a primary residence, you may not owe the IRS any tax at all. But you may owe the English tax collector. Please consult with your tax advisor or a certified public account for more details.

Published: Aug 20, 2004

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