Which debt goes first? Save money instead?

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Which debt goes first? Save money instead?

Postby Dulocracy » Wed May 08, 2013 2:39 pm

Here is the situation that I am dealing with:

Mortgage on home is $159,000 and has a 6.35% interest rate. I cannot refinance (not Freddie/fannie - is upside down by about $40k - just tried to seek options).

Car note is a total of $6,900 and ahs an interest rate of 4.45%

We have no other debt.

My tax rate (state and fed) winds up being around 35-38% (my company fluctuates in profit each year, which caused fluctuations in my rate).

I have about $30,000 invested, but cannot use that due to an agreement with my partner that we would have semi-liquid assets we can get to if we have an emergency with the company (think of it as a company emergency fund).

My wife and I put money into retirements and we just got our retirements set due to advice from boghleheads, so we are not going to revisit the amount we put there.

We plan on beginning the process of having a baby in March of 2014, but have no money set aside for this experience.

I want to get the mortgage down to refinance it (though that will not happen quickly), pay off the car, and have enough money to have a baby. Where do we put the money? Split it? Pay off the car for the cash flow/ automatic return? Pay down the mortgage to refi? I am led to believe that babies cost money, so there is that. Thoughts?
I'm not a financial professional. Post is info only & not legal advice. No attorney-client relationship exists with reader. Scrutinize my ideas as if you spoke with a guy at a bar. I may be wrong.
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Re: Which debt goes first? Save money instead?

Postby ShowMeTheER » Wed May 08, 2013 2:42 pm

Dulocracy wrote:I am led to believe that babies cost money, so there is that. Thoughts?


Absolutely correct.


Let's start here:

How much money do you have, or expect to have available to pay towards these debts in the next year? How much time left on that car note?
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Re: Which debt goes first? Save money instead?

Postby Dulocracy » Wed May 08, 2013 3:43 pm

The car note will be there until 7-14. (Edited to add 7-20-2014 is the payoff date for clarity).

I anticipate having an extra $400 - $500 a month to set aside. Wife's insurance apparently pays for all but $500 of the baby being born.

Wife is supposed to have a pay increase in March. She knows that the range will be $166/mo to $300/mo. (Part of the reason we picked March as the time to try to start a family... giving us 9 months after that to save as well (although probably less because of caring for a pregnant wife).
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Re: Which debt goes first? Save money instead?

Postby mlipps » Wed May 08, 2013 3:48 pm

Assuming you're itemizing, your effective rate on the mortgage is close to 4.1275, so the rates are pretty close to the same. With the car already being paid off relatively soon, I'd probably focus on the mortgage & see if you can pay it down enough to refinance, but that does seem pretty far off.

Can you refinance the car? Penfed has consistent offers around 1.99%.
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Re: Which debt goes first? Save money instead?

Postby Twins Fan » Wed May 08, 2013 4:47 pm

I'm a bit confused at how you're in the 35-38% tax bracket, married/two incomes, no kids yet, I'm guessing a pretty reasonable mortgage payment, a car payment, now other debt, and don't have a whole bunch of extra cash around. Should mean you have a pretty hefty income, no?

Regardless, as to what you posted about... I'm a debt averse type myself and one of the Dave Ramsey things that I like is his "snowball effect". That's where you tackle the smallest balance debt first without worry of the interest rate or "numbers". I did that when I got rid of my debt (cc's, car payments, and such... still have a mortgage) and it was a satisfying way of doing that. A mental boost kind of thing. So, I say knock out the car payment as soon as you can. Then you can decide what to do from there. Maybe split between paying down the mortgage and saving for the baby? Maybe wait one more year before starting to try to have a baby?
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Re: Which debt goes first? Save money instead?

Postby JupiterJones » Wed May 08, 2013 5:04 pm

How much is the car worth? You might be able to sell it and then pay cash for an el-cheapo-mobile.
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Re: Which debt goes first? Save money instead?

Postby Dulocracy » Wed May 08, 2013 6:32 pm

Twins Fan wrote:I'm a bit confused at how you're in the 35-38% tax bracket, married/two incomes, no kids yet, I'm guessing a pretty reasonable mortgage payment, a car payment, now other debt, and don't have a whole bunch of extra cash around. Should mean you have a pretty hefty income, no?

Regardless, as to what you posted about... I'm a debt averse type myself and one of the Dave Ramsey things that I like is his "snowball effect". That's where you tackle the smallest balance debt first without worry of the interest rate or "numbers". I did that when I got rid of my debt (cc's, car payments, and such... still have a mortgage) and it was a satisfying way of doing that. A mental boost kind of thing. So, I say knock out the car payment as soon as you can. Then you can decide what to do from there. Maybe split between paying down the mortgage and saving for the baby? Maybe wait one more year before starting to try to have a baby?


My firm has income that is not realized. We put a lot of money into developing the firm and its infrastructure. We paid with loans. Apparently, we did get to deduct the income in the past (which was nice), but now the money that is going to pay the loans cannot be deducted (it was deducted once at the time of purchase). The debt was a good thing in that it has allowed us to grow in a way we would not otherwise be able to grow. Paying almost all of it off in short order was also a good thing. The fact that our taxes are out of whack for a few years is not so good. I am not complaining- without taking on the debt, we would not have all the income to pay it off. That income in the future should continue to grow, allowing for real profit instead of "ghost profit." We are about two years out from that, from my understanding.

Also, 20% of our gross income goes into ROTH 401k accounts (something that has been debated at length on other threads - both percentage and ROTH).

JupiterJones wrote:How much is the car worth? You might be able to sell it and then pay cash for an el-cheapo-mobile.


Unfortunately, I drive a lot. How much is a lot? 35k miles a year. I got a car that was $20,125 (VW Jetta) that was much more enjoyable to drive. My quality of life went way up, but it was a fairly inexpensive new car (in line with a Honda/Toyota). Should I have purchased new? Moot point, since I did it pre-boglehead days. The car is now 3 years old, which is where I would buy used. I plan on driving it for 10-12 years. Since I have three offices around the Metro-Atlanta area, there is no real way to move closer to one (although the upside down mortgage would prevent that anyway).

mlipps wrote:Assuming you're itemizing, your effective rate on the mortgage is close to 4.1275, so the rates are pretty close to the same. With the car already being paid off relatively soon, I'd probably focus on the mortgage & see if you can pay it down enough to refinance, but that does seem pretty far off.

Can you refinance the car? Penfed has consistent offers around 1.99%.


Because my credit has been extended for the above referenced debt for the business, refinance will not work because of debt to income ratio. (They will only consider my salary, not the business proceeds that actually pay the debt (that is almost paid off). This means that until that is paid, re-fi is not going to happen on the car). Good credit, though.
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Re: Which debt goes first? Save money instead?

Postby Toons » Wed May 08, 2013 6:43 pm

Pay off the car :happy
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Re: Which debt goes first? Save money instead?

Postby stan1 » Wed May 08, 2013 6:44 pm

First, I would build an emergency fund equal to 3-6 months of expenses to help you manage cash flow needs. You can use this to dip into if you need to make car repairs, or if you have unexpected expenses related to childbirth. The idea is that you don't want to have to borrow in the future for unexpected expenses. Rebuild the emergency fund if you have to dip into it. After that I would pay off the car loan, if it isn't already done, since the balance will be low and then focus on paying the mortgage down so you can refinance.
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Re: Which debt goes first? Save money instead?

Postby Calm Man » Wed May 08, 2013 9:46 pm

I think the most important thing is after the baby comes to be. If your wife and you both keep working I think you will be fine. If one of you stops it may not be so good. I would build up a big reserve and pay off debt as you can. The rates are pretty high on the debt so I might save a little less in deferred accounts to pay them off a little faster. Good luck.
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Re: Which debt goes first? Save money instead?

Postby Watty » Wed May 08, 2013 10:18 pm

My tax rate (state and fed) winds up being around 35-38%
......

Also, 20% of our gross income goes into ROTH 401k accounts (something that has been debated at length on other threads - both percentage and ROTH).



Putting money in the Roth 401K in that tax bracket does not seem to make sense.

Could you put the money into a regular deductible 401K and use the tax savings to pay down the loans?
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Re: Which debt goes first? Save money instead?

Postby Dulocracy » Thu May 09, 2013 3:06 pm

Calm Man wrote:I think the most important thing is after the baby comes to be. If your wife and you both keep working I think you will be fine. If one of you stops it may not be so good. I would build up a big reserve and pay off debt as you can. The rates are pretty high on the debt so I might save a little less in deferred accounts to pay them off a little faster. Good luck.


I think that my plan of attack will be to pool some money just because babies cost money and attack the car note with the rest of any money we have.

As an interesting good note: I spoke to the president of the local credit union (with whom I have had dealings in the past), and she indicated that they may be able to refinance even though it is not fannie/Freddie and is upside down. I will look into it (though I am worried about what the terms would be).

Watty wrote:
Putting money in the Roth 401K in that tax bracket does not seem to make sense.

Could you put the money into a regular deductible 401K and use the tax savings to pay down the loans?


Since I keep getting this question, I put the whole situation here: viewtopic.php?f=1&t=116129

I have been told by several bogleheads that in my situation, it is borderline, but better to use ROTH. Having so many people question it made me decide to get a broader perspective. I would welcome your thoughts there.
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Re: Which debt goes first? Save money instead?

Postby JupiterJones » Thu May 09, 2013 4:47 pm

Dulocracy wrote:
JupiterJones wrote:How much is the car worth? You might be able to sell it and then pay cash for an el-cheapo-mobile.


Unfortunately, I drive a lot. How much is a lot? 35k miles a year. I got a car that was $20,125 (VW Jetta) that was much more enjoyable to drive. My quality of life went way up, but it was a fairly inexpensive new car (in line with a Honda/Toyota). Should I have purchased new? Moot point, since I did it pre-boglehead days. The car is now 3 years old, which is where I would buy used. I plan on driving it for 10-12 years. Since I have three offices around the Metro-Atlanta area, there is no real way to move closer to one (although the upside down mortgage would prevent that anyway).


Well there you go. Life is all about choices and trade-offs. It's about prioritizing your wants and needs.

You want to get rid of your car debt quickly so you can be in good financial shape to have a baby sooner rather than later. You also want to drive a comfortable car that you find "enjoyable" and that is no older than three years.

I'm simply pointing out the fact that de-prioritizing your "car wants" would help you realize your "baby wants".

Whether you actually want to make the trade-off in that direction (instead of the direction it's currently being made) is totally up to you, of course. We all prioritize differently.

I'm not a big fan of babies myself, so I can't blame you there. But I am a big fan of not being in car debt. :D
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Re: Which debt goes first? Save money instead?

Postby Meg77 » Thu May 09, 2013 5:04 pm

I'd get rid of the car note asap. It's easy and offers short term gratification and payoff. If you put an extra $500 a month on that you can probably have it paid off in about 6 months. Then you'll have that $500 back plus whatever your car payment is to boost cash flow - I'm guessing around $1000. By then you'll have a better idea perhaps of what your short term goals are (i.e. wife might be pregnant so preparing for baby might be your main focus - or you may have realized you have fertility issues that need financial attention - or whatever).

In any event once you pay off the car, just roll that extra $1000 a month into a savings account to use refinance the house if and when you qualify. I would save that money in cash not apply extra payments directly to the mortgage. That way if you end up with other more important goals popping up (a kid with special needs, private school tuition, moving to a new house) then you have the cash there and can abandon the refinance plan. If you do end up qualifiying you can just pay the cash down at the re-fi closing instead of paying the mortgage down first. And by the way I don't know where you live but real estate prices are rebounding so that might help youu ability to refi sooner than later. On other other hand rates might be back up to 6% range in a couple of years so it may be a moot goal.
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Re: Which debt goes first? Save money instead?

Postby Dulocracy » Thu May 09, 2013 5:16 pm

My (why I don't sell my car) car analysis without taking into account that my commute went from miserable to neutral in my happiness indicator:

$6,900 would buy a crap car that is not reliable that would not last as long as my current car.
My current car was maintained well by someone who drove it well (me).
My car has a long life expectancy.
Replacing my car with another of equal value (used) would cost $15,000 to 18,000.
I need reliable transportation for the long term.
Doing a cost benefit analysis with what I could buy vs. what I have now, I think that staying the course is better for the long term overall financial picture. Whether right or wrong, I like the idea of having a well-maintained, reliable car for the next 9-10 years (or more if I can squeeze it out).

As a side note to show I am not just being the guy who wants a flashy fun car (although it is not that flashy): a guy on a bicycle hit my car. Yup. Left a big dent. After yelling about how his disk hurt (not his back, mind you... he diagnosed it as his disk), an ambulance arrived. He was surprised when he got a ticket (due to a wonderful witness who stopped and explained that I had a turn arrow and the guy aimed for my car when I was turning (he was also crossing at a point where it would not be legal for him to do so). THE POINT: He obviously did not have insurance or money to fix my car. I have not repaired it because of the $300 cost that could go toward putting us in a better financial position. I drive the dented car on purpose. Whether right or wrong in the above analysis, at least my intentions are in the right place.
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Re: Which debt goes first? Save money instead?

Postby JupiterJones » Wed May 15, 2013 5:26 pm

Dulocracy wrote:I drive the dented car on purpose.


It serves as a warning to other bicyclists. :-)
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Re: Which debt goes first? Save money instead?

Postby tractorguy » Thu May 16, 2013 10:27 am

My oldest daughter was in the same situation as you a couple of years ago. My SIL even drove a VW product (Golf). They
1) made sure their emergency fund was fully funded. Paying cash for car breakdowns or children's furniture or etc. is much better than running up credit card debt.
2) paid down the car loans as fast as possible. There is a psychological boost to getting out from under that makes it easier to attack the next.
3) Once the car loans were paid down, they aggressively paid down the mortgage. They didn't take any of the pay raises into life style but used them all to add to savings or paying down debt.

This has turned out well for them. He got some nice pay raises. They channeled the extra money into the mortgage and were able to turn a $50K deficit into a $10K equity position by the time they sold this year. It helped that the market in the DC area is starting to heat up a bit.

I would not sell the car. The spread between the price you can sell a car at and the price you can buy a car at is huge. Dealers make lots of money on used cars. Most economical way to live with a car is to drive it into the ground. And, if you do have a baby, you are going to want something at least as large as the Jetta.

Be aware that the medical expenses of having a baby is the tip of the iceberg. The next big issue is deciding if you're both going to continue to work and pay child care or if one of you is going to stay at home. Either way, you've got a major change in your cash flow situation with a child.
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