From: psb@matt.ksu.ksu.edu (Jr Phillip S Buckland)
Newsgroups: misc.consumers.house
Subject: Re: when does it make sense to reduce the
Date: 21 Jan 1993 15:58:42 -0600
Organization: Kansas State University
Distribution: na
NNTP-Posting-Host: matt.ksu.ksu.edu

rat@erg.sri.com (Ray Trent) writes:

>You still don't get it do you?

	I most assuredly do "get it", Mr. Trent.  What is most clear
	in this exchange is that neither one of us is doing a good job
	of making our positions understood by the other.

[...]

>I mean, ok, let's be really generous and assume that the credit card
>has exactly the same rate as your mortgage (adjusted for tax
>advantages), and instead of *infinite* amortization, it is amortized
>over the *same* period as your loan. It is *exactly* the same as
>having 2 mortgages. I.e. the principle + interest on the mortgage plus
>the principle + interest on the credit card equals the principle +
>interest on the combination. *Clearly* it doesn't matter which loan
>you put your *extra* money into in this case as long as you keep the
>combined cash flow into the 2 accounts constant over the life of them.

	It *does* make a difference where one puts extra money in this
	scenario.  In this case, it makes more sense to pay down the
	loan with the lowest outstanding principal balance since that
	loan would be paid off faster, given a fixed extra amount.

>Now, since a credit card typically has a higher rate than a mortgage,
>it also would *clearly* be a win to apply the extra amount to the
>credit card if it were amortized the same as your mortgage. Right?

	Wrong.  It depends upon the outstanding balance of the cc w.r.t.
	the mortgage.

>Unless you can find some way to make the difference between instant
>amortization of the credit card (*exactly the same*, by definition)
>and an identically amortized credit card (a winning investment by the
>above argument) non-monotonic, you *have* to admit that the credit
>card is a "better" or at least "equally good" investment.

	Monotonicity is not the important characteristic.  Again, if
	you were to plot the outstanding principal balance w.r.t. time
	for the two loans, the important consideration is the *area*
	under the principal balance curve.  The loan with the greatest
	area yeilds the best return on extra dollars "invested", because
	the leverage of those dollars is greater due to the nature of the
	loan.  If the areas are equal but the loan terms are different,
	one would split the extra payments in order to keep the areas
	equal.  This results in optimal repayment of loans given a fixed
	dollar amount available.

	Your scenarios require having a *variable* dollar amount
	available.  That is, once one debt is paid off, the amount that
	was being applied to that debt is applied to the remaining debt.
	Whether or not this results in faster reduction of debt than the
	fixed amount approach depends upon the level of debt and the mix
	of terms (high/low interest, long/short debt life, etc.).

>When you add in the fact the the interest on your mortgage is
>deductible, whereas the interest on the credit card is not, it pushes
>the decision so far over towards the credit card (almost regardless of
>what your mortgage and credit card rates are) that any other
>consideration is almost laughable.

	You are quite bold in your assertions.  What is really important
	is the mix of debt instruments that an individual holds.  That the
	tax code encourages one kind of debt holding over another (and that
	it also encourages remaining in debt over being debt free) is only
	a minor factor.  There are ways to continue to shelter income/assets
	besides reliance upon a mortgage deduction (which will likely be
	capped/reduced under Mr. Bill).  Such ways are available only to
	those who have adequate discretionary cash available.  When my
	mortgage is paid off, I will have such discretionary cash and the
	means to shelter it.


We read the world wrong		| Phil Buckland
and say that it deceives us.	| psb@eece.ksu.edu
Tagore, from Stray Birds	| psb@matt.ksu.ksu.edu
Newsgroups: misc.consumers.house