Classic debt repayment vs invest scenario

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills.
Post Reply
Topic Author
viking112347
Posts: 26
Joined: Sun Apr 22, 2012 6:41 pm

Classic debt repayment vs invest scenario

Post by viking112347 »

Non-Mortgage Debt:

Wife student loan: 12,900 left at 3% fixed
2011 CR-V: 16,000 left at .9%

Mortgage: 372000 (30 year fixed 3.625%)

Emergency Fund: 46,000 cash (earning .5% at bank) + 25,000 I-Bonds
Taxable investments at Vanguard: 20,000
Roth IRA: 22,000
401K: 250,000
529: 14,000

Household income: 195,000/year

Plan: Payoff student loan this week which would reduce cash to 33,000. Apply payment I was making to student loan to car loan to accelerate payoff. After car paid off begin acceleration of mortgage payoff.

Will continue to max ROTH and 401K and invest in taxable as much as possible.

Sound like a good plan or would you all recommend a different approach?
robocop
Posts: 255
Joined: Fri Jan 27, 2012 8:44 pm

Re: Classic debt repayment vs invest scenario

Post by robocop »

I don't think there is enough info. to make a wise decision. What is your tax bracket, and what is your effective mortgage interest rate when you consider your tax deductions on the interest you pay? Do you have one child, or do you expect to have more? What is your age, your spouse's age, and how long do you plan to work?

Without knowing anything more- If I were you I would probably pay off the student loan debt with reserves, but keep the auto loan because it is such cheap debt. I wouldn't pay off a mortgage with such a good interest rate. Heck, I might even not pay anything off and focus on taxable investments, as I am still earning 4% on 10k in a rewards checking account. But the student debt would be tempting, as it is non-dischargeable and thus scarier to me.
User avatar
grabiner
Advisory Board
Posts: 35265
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Classic debt repayment vs invest scenario

Post by grabiner »

With $195,000 income, you appear to be in a 28% tax bracket and your student loan is not deductible. Therefore, you get a 3% return on paying down the student loan, and that is a short-term benefit because you can pay it off all at once. You get a 2.61% return on paying down the mortgage, and that is a long-term benefit because it won't save you any money until the mortgage is gone. And you get an 0.9% return on paying off the car.

Therefore, the student loan should go first. There isn't much benefit from paying off the car loan, but there isn't much cost either, so you might pay it off for psychological reasons as long as it doesn't deplete your emergency fund. (Remember that your emergency fund can be smaller once the loans are gone, as you will have fewer cash-flow demands.)

Paying down the mortgage looks like a very close decision. I wouldn't pay it down until you have a fully funded emergency fund and are considering only taxable investing. And even then, it's not clear that you want to pay it down. Admiral shares of Long-Term Tax-Exempt earn 2.60%, the same as your mortgage paydown, with very little risk. You might go into the 33% tax bracket in a future year, which would reduce the mortgage cost to 2.43%. Even in the 28% bracket, if there is a tax-exempt fund for your state, you will actually come out slightly ahead investing in municipal bonds. Meanwhile, you retain the opportunity to pay off or refinance the mortgage later if rates change. (I am not necessarily recommending that you invest in municipal bonds, only that a municipal-bond investment is a fair exchange.)

If you have enough spare cash flow to pay down the mortgage faster, one option would be to refinance to a 15-year loan at a lower rate.
Wiki David Grabiner
Goalie50
Posts: 30
Joined: Sat Feb 11, 2012 11:33 am

Re: Classic debt repayment vs invest scenario

Post by Goalie50 »

I agree with robocop that your age matters here. You also didn't say how many kids or their age(s). But even without that info I would say this: Don't pay off any of the debts beyond the regular payments (which are presumably on payment plans that gradually reduce the principal, and not on some interest only plan). If your taxable accounts are meant to be for long-term retirement, I would just dump more money into that. You'll get a far better return on $10,000 extra cash today put into a well-balanced portfolio over the long haul than you will versus paying off those low interest debts.
Last edited by Goalie50 on Fri Dec 26, 2014 9:32 am, edited 1 time in total.
Bob's not my name
Posts: 7417
Joined: Sun Nov 15, 2009 8:24 am

Re: Classic debt repayment vs invest scenario

Post by Bob's not my name »

viking112347 wrote:Mortgage: 372000 (30 year fixed 3.625%)
Household income: 195,000/year
Will continue to max ROTH and 401K
viking, your tax situation is interesting. It's not clear if you and your wife both have 401k's. If you both do, maxing them would reduce your MAGI to around $155,000 (which is the top of the student loan interest deduction phaseout), and your taxable income to maybe $125,000, so well down in the 25% bracket.

On the other hand, if only one of you has access to a 401k, your MAGI might be around $173,000, and your taxable income may be very close to the 28% threshold at $142,700. You might also be caught by the AMT, with an effective marginal rate of 32.5%. If you have a state income tax your marginal rate could exceed 40%. In this scenario you might want to use a spousal TIRA for the uncovered spouse to shield $5,000 of income from the high marginal rate.
Post Reply