 Selling
stock to pay off HELOC
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 Dear
Dr. Don,
I have a home equity line that has gone from 4.25 percent interest
to 6.75 percent over the past two years. I have some stocks that
I could cash in to pay this loan. Wouldn't it be better to pay off
the line than to keep the stocks? Right now with the stock market,
you never know which the better way to go is.
-- Steve Sellout
 Dear
Steve,
You're not alone in facing the rising costs of
a home equity line of credit, and the stock market is never a sure
thing, while paying off your mortgage guarantees the interest savings.
The stock market, like the interest rate on your adjustable-rate
loan, will continue to fluctuate.
Assuming you're able to use the mortgage interest
deduction on your taxes, then your effective rate on the mortgage
is approximately the mortgage interest rate times 1 minus the marginal
federal income tax rate, or the combined federal and state tax rate
if you can also use the mortgage interest deduction on your state
taxes. If you are in the 25 percent marginal federal income tax
bracket, ignoring state taxes, the effective cost of your 7 percent
mortgage is 5.25 percent. 7 x (1 - 0.25) = 5.25 percent. The CCH
calculator will help you figure out the effective rate on your
mortgage loan.
It
makes sense to prepay your mortgage if you expect to earn a lower after-tax return
on your investments than the effective rate on your mortgage. In this example
it would make sense to prepay your mortgage if you expected to earn less than
5.25 percent on your investments on an after-tax basis. Although there are no
guarantees, the Fed should be pretty close to the end of this tightening cycle
in raising the targeted Federal Funds rate.
The stock market, as measured by the returns of the
S&P 500 index, has, at this writing, a year-to-date return of
2.19 percent; a three-year return of 12.88 percent; and a five-year
return of -1.11 percent. Past performance is, however, of no real
use in predicting future returns on the stock market. Tax considerations
in selling the stock may also influence your decision.
Another thing to consider is what you're going to do with the money
you free up in your monthly budget by paying off the home equity
line. If you free up $300 per month in your monthly finances by
selling off your investments then, other things being equal, you
should be investing that $300 per month toward your future financial
goals. If you're selling off your investments to free up money in
your monthly budget for current consumption you'd have to be up
against it before I would recommend that course of action. Are you
up against it?
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