I have $2,600 left in student loans which are accruing 5% interest. I also have a $73,000 2nd fixed mortgage at 5.99% interest. The first mortgage is at 4.5% interest. I'm trying to decide which to apply additional monthly funds to -- the student loan (which would be nice to be done with) -- or the 2nd home mortgage which has a higher interest rate. My first instinct is to say apply any additional monthly funds (ex an extra $300/month) to the higher interest loan (the 2nd mortgage) but I'm not sure whether this has some tax advantages -- so I should put the extra funds to the student loans first. Any insights would be appreciated.

Zip Code: 02108

We get this question a lot.

For starters, you want to compare the after-tax interest rate of these two loans. Unless you owe more than $1.1 million on your home mortgage, your mortgage interest is fully deductible to you. So based on your tax rate, the after-tax cost of this debt will be close to 4% per year.

For your student loan interest, you can deduct the first $2,500 of student loan paid each year. However, for 2010, this tax break phases out at $75k if single or $150k if married. So if your income exceeds the applicable threshold, the after-tax cost of your student loan interest would be 5%.

Based on this one factor, you'd want to put all your extra money towards your student loan debt. There are other factors to consider, however. A big one is that you can't re-borrow student loans that you pay off, while you can re-borrow against the equity in your home. So depending on if you plan to move to a new home in the foreseeable future, you might want to pay down some of your home mortgage, and keep paying the minimum on your student loans.

In your case, since you only owe $2,600 on your student loans, you might as well pay that one off first, and then begin to chip away at your second mortgage. If you owed substantially more in student loan debt, I think you'd want to run through a few different scenarios before deciding what to do.

Zip Code: 01801

Thanks. That's a really clear answer. We wouldn't get any tax benefits to the student loan, whereas we do get tax benefits of the mortgage interest.