Ask Money

Which at debt first

Chris Farrell Aug 20, 2010

Question: I have three debts that I’m paying off and will have an extra $200/month to put toward repayment.

-30 yr fixed mortgage 5.17%
-2nd Mortg Credit Line, variable 3.99% currently
-Loan from my 401K at 7%

Which should I put the $200 towards? Jay, Eagan, MN

Answer: For now, I would remove the fixed rate mortgage from your list. You can go after that later on. Instead, you want to eliminate the other two loans.

Each loan carries a different risk. The danger built into your equity line of credit is that the rate on the loan will climb when as the economy recovers. Of course, that day is probably far off.

The main risk built into your 401(k) loan is if you lose your job you have 6 months to pay back what you owe. Anything remaining after the 6 month period is considered an early withdrawal subject to ordinary income taxes and a 10% penalty.

Here’s what I would do: I would take advantage of the low rate on your home equity line of credit. Pay the minimum on it each month to free up even more money than the extra $200. Take the $200-plus in extra savings and attack the 401(k) loan. You’ll save money this way, too, since it’s also your highest rate debt at the moment. I’d agggressively put back money into your retirement plan. Once the loan is extinguished I would take your savings to target the home equity line of credit.

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