Pay Mortage, Student Loans or Invest

[drpocket]

Hello, long time lurker, first time poster. So first ,thank you to everyone for all that I have already learned on this site.
I am at a sort of crossroads right now, and I am just wondering what people on this board would do if they found themselves in my situation.

Here is the deal. My wife and I our in our late 30s, and own a house in Chicago which is somewhere around 30k underwater. (228K left on mortgage, approx house value is 200K.) Mortgage rate is 5.5%. 27 years left on the mortgage. We are not eligible for a HAMP refinance because the mortgage was taken out in Nov 2009.
We also have about 50K in student loan debt. (Monthly payment $325, 3.3% interest rate).
We have no other debts, and have about 6 months of emergency savings, and some small non-retirement investments. We are currently saving 5% for retirement.

At this point, the mortgage payment is about 40% of our monthly take home income. At the end of each month we have about $300 dollars unspoken for, and i am wondering, if you were in my shoes, would you use that money to:
1) Increase pre-tax retirement savings. We are no where near maxing out our retirement.
2) Pay additional principle on the mortgage in the hopes of being able to refinance within the next 2-3 years.
3) accelerate the payment of the Student loan.

My gut instinct is to pay the mortgage with the idea that I would get an immediate 5.5% return on the additional principle payments, and lowering the monthly payment would free up more $ for retirement savings later. Additionally, were I to refinance at a lower interest rate, I would essentially be saving the difference in the remaining loan balance. (e.g. a $200,000 mortgage at 4.5% vs 5.5% would save about $1500 a year, or would it?)

Please feel free to tell me where my thinking is/is not askew, and why?

Thank you.

[robocop]

If I were you, I would actually take a different approach then you are.

First, I would take an auto loan on my car(s) at PenFed to tap into any vehicle equity. They have loans at 1.49%, which could give you money to pay off higher interest debt or to boost your EF.

Second, I would also be concerned about having a higher EF if I were you, because you own a home and your payment is a larger percentage of your income. If anything were to happen to one or both of your jobs, or if there were a major repair needed on your home, you could find yourself in a pickle very quickly.

Once I did that, I would direct that $300 a month into retirement savings. 3.3% and 5.5% aren't that bad of long-term interest rates (remember when CDs earned more than that?), so I would be more concerned with not getting money into retirement space to take advantage of the time effect of compound interest.

I'm not confident that saving for a refi would be a good choice for you, as it would take a long time at $300 a month to get 20% equity, and I'm not sure if it would be worth it to refinance if you will end up with a similar interest rate after PMI/MIP anyway. That said, I don't own, or know how much PMI/MIP would add to your refi rate, so I will let others on this forum speak to the wisdom of using your monthly savings (and any vehicle equity you can pull out) for a refi as opposed to retirement.

[grabiner]

I would suggest going after the mortgage. It's an immediate 5.5% return (taxable, assuming you itemize deductions, so 4.18% after tax if you are in a 25% bracket) and in a few years, you'll probably be able to refinance at a lower rate and get even more savings. The faster you pay it off, the sooner you will be able to refinance, although you can't do much about the other factor in refinancing, which is what happens to home prices. When you do refinance, you can allocate the extra savings to your retirement accounts.

If the student loans are at 3.3% fixed and tax-deductible (2.48% after tax in a 25% bracket), you should make only minimum payments on them until you can save enough to max out your retirement accounts.

[bdpb]

I would suggest going after the mortgage. It's an immediate 5.5% return (taxable, assuming you itemize deductions, so 4.18% after tax if you are in a 25% bracket) and in a few years, you'll probably be able to refinance at a lower rate and get even more savings. The faster you pay it off, the sooner you will be able to refinance, although you can't do much about the other factor in refinancing, which is what happens to home prices. When you do refinance, you can allocate the extra savings to your retirement accounts.

If the student loans are at 3.3% fixed and tax-deductible (2.48% after tax in a 25% bracket), you should make only minimum payments on them until you can save enough to max out your retirement accounts.

I agree with this advice. I would go even further.

Sell your non-retirement assets to pay down the mortgage.

In addition, I would withdraw and stop Roth IRA contributions to pay down the mortgage enough to refinance (with no PMI). It doesn't matter that they are retirement assets because you will have the same net worth either way. By refinancing, in addition to lower payments because of the lower interest rate you will end up with a lower payment due to extending the term from 26 years to 30 years. Once you've refinanced use the difference in mortgage payments to increase funding your retirement accounts, especially the tax deductible accounts.

[drpocket]

Thank you for your advice. I appreciate it.

I am glad to see that I am not completely daft in my desire to pay down the mortgage, but I also see the first responders point about having a bigger emergency fund. I suppose one thing that I neglected to point out is that all of this concern was spawned because my wife is losing her job, so the numbers represent only my current income. I am trying to develop a plan that allows us to live fully on my earnings, so that if/when my wife returns to work all of her money after day care can be put toward savings.

I have thought about both selling non-retirement assets and stopping retirement, but I am wondering how to weigh the cost/benefits of that. Stopping retirement savings would double the amount I could apply to principle each month ($600). That means that in all likelihood it would still be about 2-years before I would even begin to build equity in the house, assuming that this is the year prices bottom out in Chicago. That would mean probably another year before I could refinance. So we are looking at 3 years before I could refinance. Selling my non-retirement investments would take maybe a year off of this process. So is worth it stop retirement for 2-years to pay this down?

Thank you.

[NorCalDad]

You mentioned that your wife is losing her job. This is a big factor that changes what I was going to advise. How certain are you that you can still afford your expenses on your income alone and still have money left over?

Having been in your underwater shoes for a brief period before our housing market took off in the last year, I was going to advise paying down your mortgage because of your high interest rate and to gain peace of mind. However, if you are going down to one income and if there is any possibility it does not make financial sense to stay, I would not devote that extra money to principal. If you someday have to short sell or walk away, you would be better off having saved that money in your retirement accounts or for emergency savings that you may need to draw upon.

[drpocket]

You mentioned that your wife is losing her job. This is a big factor that changes what I was going to advise. How certain are you that you can still afford your expenses on your income alone and still have money left over?

On paper, yes. I have run the numbers several times and it looks like we will have a monthly surplus of $300-$600, not counting what I am currently saving for retirement. It does make me nervous that I haven't yet actually tested the budget, but I have a really good feel for what we are spending on everything. So I would say I am 90% confident in the numbers I have given.

Having been in your underwater shoes for a brief period before our housing market took off in the last year, I was going to advise paying down your mortgage because of your high interest rate and to gain peace of mind. However, if you are going down to one income and if there is any possibility it does not make financial sense to stay...

At this point, I would say a short sale is unlikely. At a bare minimum, we should be able to break even and preserve our current savings over the time my wife is unemployed. I know that things change, but my job is pretty secure. And I work in a field where I should be able to find employment fairly quickly if the need arises. We bought this house with every intention of growing old in it, and that desire has not changed. So unless the housing market completely collapses again, it would be really hard for us to just walk away as long as we can make the payments on the house.

From all of the conversations and advice I have been given thus far, I am wondering if a good plan might not be to take whatever I can apply to the principle each month and put it into a separate savings account. Then every 6-mos or so making a lump sum payment toward the mortgage? Does that make sense? Or should I just go all in one way or the other?

Thank you.

[Clearly_Irrational]

You have a very small cash surplus, in my opinion you need to fix that before anything else. Recommendations:

1) Reduce retirement savings to the minimum amount needed to get your employer match
2) Reduce student loan payments to the minimum to free up more cash flow
3) You're paying a very high rate on your mortgage for today's environment all extra cash should go to paying down your mortgage to the point where you can refinance.

Once your mortgage is refinanced take another look at your finances and see how much you need to save in order to retire at 67 (Social Security Age) and make sure you're saving at least that much. I'd put the rest to paying down student loan debt.

[MN Finance]

You said that you have non-retirement investments? How much?

If you have 27yrs left on a 228k mortgage at 5.5% you are paying 1350/mo P&I plus, I assume, 100/mo+ PMI, for at least 1450/mo. If you can use $60k in cash and/or non retirement investments to get down to an 80/20 loan at 4%, then that's 765/mo and no PMI (reamortized 30 yr). That's a savings of $8k per year on $60k in capital and you have freedom in your house situation plus some protection if you lose your job because your monthly payments are less. No idea if you have anything near $60k, but if you do and/or possibly need to take a couple months out of your emergency fund, then you should look at it.