Getting out of my debt vs using tax advantaged space - which is better?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Sporkthef
Posts: 5
Joined: Thu Jun 11, 2015 3:49 pm

Getting out of my debt vs using tax advantaged space - which is better?

Post by Sporkthef » Tue Aug 16, 2016 3:20 pm

A little background stats: I'm 35, my wife is 26, and we have a 1 yr daughter with another expected early next year. We just built a house this year and while I did plenty of spreadsheets on the costs and budgets, I'm starting to feel overwhelmed and second guess myself. I used to be ok carrying debt and managing it but as our daughter grows up I find myself wanting to be more financially free. So I have a plan but want to to see what some other opinions are.

We live in the midwest in a LCOL area, combined gross salary 113,000.

Savings
401k - 10,000
457 - 26,000
IRA - 10,000
Roth IRA - 6,500
Liquid Savings - 4,000
Also have a pension that i've been paying into for 5 years. I don't know if I'll stay till I retire but if I leave I have the option to get all that I've put in plus interest. Estimated value 25,000

Debts
House (1500/month @ 4.25%) - 282,400
Rental (780/month @ 4.25%) - 140,800
SUV (392/month @ 3.2%) - 24,300
Variable Student Loan (180/month @ 5.1%) - 17,600
Federal Student Loan (165/month @ 4.5%) - 21,000
Credit Cards (0%) - 14,000
401k Loan - (200/month) 5,300
457 Loan - (160/month) 13,900

The loans are paid to myself with interest so they don't bother me as much. We have two other paid off vehicles, I am selling one that is worth about 4K. The other is reliable but worth much less as it is almost 20 years old. I know it makes more sense to sell the SUV but the wife loves it and the car I'm selling is a previosuly salvaged car and she doesn't our like daughter riding in it. We both need a car and we both pick up and drop off for daycare.

I'm currently renting the other house to my brother who will likely purchase it and take advantage of current low interest rates. Without a realtor I will net about 14k from the sale. So I will have a lump sum of about 18k after the sales.

Not counting the minimum payments, we have about 1400/month extra to put toward debt. Thats while stashing 500/month in savings but only the minimum in retirement accounts to get the match. Paying back the 401k/457 loans first would give us the most cash flow. I'm playing the 0% game with the credit cards, won't be adding to that at all.

We already want to downsize, but to not lose our ass in the new house we need to stay for a few years. Luckily there are no lots left in this area and it is desireable. Pretty much why we jumped in before we were ready. On paper it works, just tight.

letsgobobby
Posts: 10616
Joined: Fri Sep 18, 2009 1:10 am

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by letsgobobby » Tue Aug 16, 2016 3:32 pm

boy, I'd be stressed too. You owe $500k+ on a salary of $113k.

When you are you going to change your lifestyle to match your income?

You might benefit from a Dave Ramsey plan. I'm not sure I hear any urgency in your (albeit short) post. Your situation is quite dire (based on what you've posted).

Sporkthef
Posts: 5
Joined: Thu Jun 11, 2015 3:49 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by Sporkthef » Tue Aug 16, 2016 3:48 pm

letsgobobby wrote:boy, I'd be stressed too. You owe $500k+ on a salary of $113k.

When you are you going to change your lifestyle to match your income?

You might benefit from a Dave Ramsey plan. I'm not sure I hear any urgency in your (albeit short) post. Your situation is quite dire (based on what you've posted).


I'm not going to blame it on my wife but before I met her I had the small mortgage, student loans, and small car payment. It has since ballooned into this and I'm trying to reign it in. I'm not TOO worried right now because the houses can be sold, the SUV can be sold, and I'm slowly converting my wife from a spender to a saver. Just trying to figure out the best way to approach.

letsgobobby
Posts: 10616
Joined: Fri Sep 18, 2009 1:10 am

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by letsgobobby » Tue Aug 16, 2016 3:54 pm

No explanation needed as to how you got in - more helpful would be a clear, concrete, written plan to get out.

If you don't know Dave Ramsey, it was a serious suggestion because I think he does help folks see clearly about debt. Ignore him for investing but for debt-reduction you could do much worse.

What is the market value of the two homes, and of all your vehicles?

Selling the 1 house helps your cash flow. Hopefully your brother comes through but if not you still ought to sell it on the market.

You really need a written budget. What are you going to do when the 0% offer on the cards ends? With an interest rate near 20% isn't that going to be about a $400 per month payment? What does that do to your cash flow?

To answer your original question: you can't afford to invest right now. Every penny you have needs to go toward debt repayment. Your situation is dire.

User avatar
Devil's Advocate
Posts: 196
Joined: Thu Feb 16, 2012 5:18 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by Devil's Advocate » Tue Aug 16, 2016 4:08 pm

+1 letsgobobby

Dave Ramsey's advice is great to get out of debt. You need to seriously read the total money makeover. It will change your life.

After you are debt free avoid his investment advice.

Good luck.

DA

delamer
Posts: 3106
Joined: Tue Feb 08, 2011 6:13 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by delamer » Tue Aug 16, 2016 4:14 pm

If you have $1400 extra to put toward debt, I am not sure why you are concerned about freeing up cashflow. It doesn't seem like it is that tight. But you do have a lot of debt, which you need to pay down sooner rather than later, and low savings.

What are you contributing toward the credit card debt? That is a lower priority as long as you can keep the 0% interest rates, but you can't ignore it.

I am not familiar with the deductibility of student loan interest, but unless that is a huge benefit I would get rid of those loans first. Once those are gone, then the car loan.

With the $500 toward savings, I would get total savings up to 6 months expenses and then contribute more toward the 401(k).

ccf
Posts: 85
Joined: Mon Mar 09, 2015 9:13 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by ccf » Tue Aug 16, 2016 4:25 pm

Sporkthef wrote:House (1500/month @ 4.25%) - 282,400
Rental (780/month @ 4.25%) - 140,800



How much rent are you collecting?

cherijoh
Posts: 4049
Joined: Tue Feb 20, 2007 4:49 pm
Location: Charlotte NC

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by cherijoh » Tue Aug 16, 2016 4:33 pm

Sporkthef wrote:A little background stats: I'm 35, my wife is 26, and we have a 1 yr daughter with another expected early next year. We just built a house this year and while I did plenty of spreadsheets on the costs and budgets, I'm starting to feel overwhelmed and second guess myself. I used to be ok carrying debt and managing it but as our daughter grows up I find myself wanting to be more financially free. So I have a plan but want to to see what some other opinions are.

We live in the midwest in a LCOL area, combined gross salary 113,000.

Savings
401k - 10,000
457 - 26,000
IRA - 10,000
Roth IRA - 6,500
Liquid Savings - 4,000
Also have a pension that i've been paying into for 5 years. I don't know if I'll stay till I retire but if I leave I have the option to get all that I've put in plus interest. Estimated value 25,000

Debts
House (1500/month @ 4.25%) - 282,400
Rental (780/month @ 4.25%) - 140,800
SUV (392/month @ 3.2%) - 24,300
Variable Student Loan (180/month @ 5.1%) - 17,600
Federal Student Loan (165/month @ 4.5%) - 21,000
Credit Cards (0%) - 14,000
401k Loan - (200/month) 5,300
457 Loan - (160/month) 13,900

The loans are paid to myself with interest so they don't bother me as much. We have two other paid off vehicles, I am selling one that is worth about 4K. The other is reliable but worth much less as it is almost 20 years old. I know it makes more sense to sell the SUV but the wife loves it and the car I'm selling is a previosuly salvaged car and she doesn't our like daughter riding in it. We both need a car and we both pick up and drop off for daycare.

I'm currently renting the other house to my brother who will likely purchase it and take advantage of current low interest rates. Without a realtor I will net about 14k from the sale. So I will have a lump sum of about 18k after the sales.

Not counting the minimum payments, we have about 1400/month extra to put toward debt. Thats while stashing 500/month in savings but only the minimum in retirement accounts to get the match. Paying back the 401k/457 loans first would give us the most cash flow. I'm playing the 0% game with the credit cards, won't be adding to that at all.

We already want to downsize, but to not lose our ass in the new house we need to stay for a few years. Luckily there are no lots left in this area and it is desireable. Pretty much why we jumped in before we were ready. On paper it works, just tight.


Yikes! That is a lot of debt and you are extremely concentrated in illiquid real estate.

Your title mentions paying down debt vs. tax advantaged space, but then don't mention any question about tax-advantaged in your post. Are you considering not putting in enough to get the match or not paying your debts above minimum to more in tax advantaged? I would probably keep putting in enough to get the match. After that you need to focus on paying down debt.

I don't see any quick hits on the debt besides the 401k loan where you could gain cash flow. I would try and sell the rental house to your brother sooner rather than later. You do not mention the rental income anywhere. Is it enough to cover your mortgage, taxes and insurance on the rental property or are you losing ground?

You list one student loan as "variable" - does this mean that your interest rate can increase? What is the rate indexed to? This might be a good loan to target with accelerated payments - perhaps with the proceeds from the sale of the second house.

You are woefully short on an emergency fund but with this much debt, I'm not sure building up your emergency fund is the best use of any free cash.

I assume your 0% credit card will lose the intro rate of 0% at some point in the future. Are you on track to pay that off before it converts to a higher interest rate? Or were you planning to bounce it to a different card with a promo rate? I wouldn't plan on that option being available to you over the long term.

Chadnudj
Posts: 660
Joined: Tue Oct 29, 2013 11:22 am

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by Chadnudj » Tue Aug 16, 2016 4:46 pm

Sporkthef wrote:Savings
401k - 10,000
457 - 26,000
IRA - 10,000
Roth IRA - 6,500
Liquid Savings - 4,000
Also have a pension that i've been paying into for 5 years. I don't know if I'll stay till I retire but if I leave I have the option to get all that I've put in plus interest. Estimated value 25,000

Debts
House (1500/month @ 4.25%) - 282,400
Rental (780/month @ 4.25%) - 140,800
SUV (392/month @ 3.2%) - 24,300
Variable Student Loan (180/month @ 5.1%) - 17,600
Federal Student Loan (165/month @ 4.5%) - 21,000
Credit Cards (0%) - 14,000
401k Loan - (200/month) 5,300
457 Loan - (160/month) 13,900

The loans are paid to myself with interest so they don't bother me as much. We have two other paid off vehicles, I am selling one that is worth about 4K. The other is reliable but worth much less as it is almost 20 years old. I know it makes more sense to sell the SUV but the wife loves it and the car I'm selling is a previosuly salvaged car and she doesn't our like daughter riding in it. We both need a car and we both pick up and drop off for daycare.

I'm currently renting the other house to my brother who will likely purchase it and take advantage of current low interest rates. Without a realtor I will net about 14k from the sale. So I will have a lump sum of about 18k after the sales.

Not counting the minimum payments, we have about 1400/month extra to put toward debt. Thats while stashing 500/month in savings but only the minimum in retirement accounts to get the match. Paying back the 401k/457 loans first would give us the most cash flow. I'm playing the 0% game with the credit cards, won't be adding to that at all.

We already want to downsize, but to not lose our ass in the new house we need to stay for a few years. Luckily there are no lots left in this area and it is desireable. Pretty much why we jumped in before we were ready. On paper it works, just tight.


A. Continue contributing enough to retirement accounts to get the match.

B. Stop stashing $500 a month in savings. Your $4k emergency fund is enough for now. Throw that $500 in with the $1400 each month towards paying down debt.

C. As for the order, I'd go: (1) 401k loan; (2) 457 loan (both relatively small, paying them off frees up cashflow, and both would be due immediately if you lost your job); (3) credit cards (because eventually you won't have that 0% benefit; pay them sooner if you might start having interest there); (4) SUV; (5) increasing your retirement savings up to the max; (6) variable student loan; and (7) fixed student loan (since your income still entitles you to deduct some student loan interest, and because you can put student loans into deferment if you were to lose your job/have a crisis).

D. Speaking of student loans, look into refinancing. You might find lower rates. And when you sell that extra car, put all the money proceeds there into paying down debt as outlined above.

E. Okay, this rental house SCREAMS bad idea to me (I should know - I once had a rental house I rented to my brother...didn't work out well). What is the rent you're getting? It better be market rate, and certainly more than enough to cover all costs. My thought is you tell your brother that he can buy it now; otherwise it goes on the market for the best possible price within 90 days. Sell that thing, and take all the proceeds and pay them towards the debts in the order outlined above.

F. Why downsize houses? Seems like you have a decent house for a growing family at a reasonable monthly cost given your salary. I'd maybe look into refinancing the house (you might be able to get lower than 4.25% right now, although you've only been in it for a year), but not moving this quickly.

cherijoh
Posts: 4049
Joined: Tue Feb 20, 2007 4:49 pm
Location: Charlotte NC

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by cherijoh » Tue Aug 16, 2016 8:48 pm

Chadnudj wrote: I'd maybe look into refinancing the house (you might be able to get lower than 4.25% right now, although you've only been in it for a year), but not moving this quickly.


OP probably needs to get rid of some debt before he can qualify for a better mortgage rate. Lenders heavily discount the amount of rent they will count against the mortgage on a rental property. The lender may have counted the full amount of both mortgages with no credit for any rents received - especially if the rental property was their former primary residence. Once the rental property is sold, it would be a good time to see if they qualify for a better mortgage rate, since they would have substantially reduced their debt.

User avatar
Watty
Posts: 11572
Joined: Wed Oct 10, 2007 3:55 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by Watty » Tue Aug 16, 2016 10:22 pm

Sporkthef wrote: I'm starting to feel overwhelmed and second guess myself. I used to be ok carrying debt and managing it but as our daughter grows up I find myself wanting to be more financially free. So I have a plan but want to to see what some other opinions are.


Half the solution is recognizing that there is a problem so that is a big first step.

One thing I have done for years is to have a spreadsheet that I update each year where I calculate my net worth each year on January 1st. That lets me see the progress over the years which really helps me see the positive improvements when the situation is a bit complex. It does not need to be anything complex.

You have a baby already an another on the way so one thing to be careful about now that you have a plan you might start panicking and overacting. With your income over the next five years you will have $565,000 in income to use to improve your situation out so be sure to keep that in mind when you feel overwhelmed.

Sporkthef wrote:Liquid Savings - 4,000


With a second kid on the way and all that debt you need a larger emergency fund. But you can also use the Roth as a backup emergency fund if you get into a bind.

https://www.bogleheads.org/wiki/Roth_IR ... gency_fund

Sporkthef wrote:Not counting the minimum payments, we have about 1400/month extra to put toward debt


Does that include day care for the kid that is on the way?

Sporkthef wrote:We live in the midwest in a LCOL area, combined gross salary 113,000.


Depending on your deductions you may still be in the 25% tax bracket. Even with the debt I would take a hard look at contributing enough to deductible retirement accounts to get just just to the top of the 15% federal tax bracket.

Sporkthef wrote:I'm currently renting the other house to my brother who will likely purchase it and take advantage of current low interest rates. Without a realtor I will net about 14k from the sale. So I will have a lump sum of about 18k after the sales.


It is time to make that sale happen or sell it to someone else while the real estate markets are still good in most areas and interest rates are still good. If he does not have a long term lease then I would try to set a 60 or 90 day goal of getting the house sold to him or getting it listed for sale. This is especially true if that is your prior home and you can still qualify for the homeowners capital gains tax exemption. Part of the issue is that the longer you have it the more chance there will be a large repair that is needed.

Having the rental may also be preventing you from being able to refinance your home with a better interest rate and to get a good interest rate of about 2% on your car loan.

In a poor real estate market a house can take a very long time to sell at a non-distressed price since you will competing for buyers with people that have to sell because of a death, divorce, job loss, or things like that.

Sporkthef wrote:We already want to downsize, but to not lose our ass in the new house we need to stay for a few years. Luckily there are no lots left in this area and it is desireable. Pretty much why we jumped in before we were ready. On paper it works, just tight.


The transaction costs of selling and buying a house can easily be 10% of the homes price. Unless you drastically downsize it will take many years, or possibly decades to break even with the expenses. If it takes ten years to break even and you will likely want to "up-size" again before you break even then you could be in a no-win situation. Buying a house that cost less might have been a better choice but there might not be a good way to undo that choice without doing something extreme like moving back into the rental property. In a bind you need to "do what you gotta do" and but you might not be there yet.

2 Tasty
Posts: 40
Joined: Tue Jul 28, 2015 9:36 am

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by 2 Tasty » Tue Aug 16, 2016 11:15 pm

With regards to the question of paying down debt vs tax-advantaged investing: I find it extremely valuable to run a spreadsheet comparison between competing strategies, and I am often surprised by the outcome. Now, without having run such a comparison for your situation (and ignoring areas where you can reduce expenses), I would lean towards maxing out tax-advantaged contributions.

2comma
Posts: 1028
Joined: Thu Jul 15, 2010 11:37 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by 2comma » Wed Aug 17, 2016 12:46 am

I think it's "appropriate" that you are feeling overwhelmed but it seems you realize it's time to take action so I have faith you'll be able to work through this. Just to give you an idea how conservative some of us Bogleheads can be we were making about double your income and bought a little over half the house and live in a LCOL midwest area like you and we've been debt free for years. With a growing family, if you love the house I'd probably try to keep it. I guess what I'm thinking is things may not be as dire as some suggest so don't overstress but remember you are at a point where if anything goes wrong (loss of job, illness, death) things could get ugly. You are both young so with a good plan to reduce debt the odds are in your favor.

I'd do the company match, probably increase my emergency funds over time (just in case but it depends on your situation mostly job wise) and with the rest I'd attack that debt (and sell the rental). Doing a budget and finding ways to cut expenses can be very enjoyable. Your goal should be to become a lender (and a saver) but not a borrower - taking steps to get there and seeing your progress is very satisfying.
If I am stupid I will pay.

orca91
Posts: 1223
Joined: Thu Mar 03, 2016 7:17 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by orca91 » Wed Aug 17, 2016 7:06 am

Similar to other posters, I say, contribute enough to get the match in tax advantaged, attack the debt, and sell the rental. You have a lot of debt. I would make that the priority.

Keep your house you just built. It will become more manageable as you get the finances sorted out and your family is growing. And, you want to convert the wife from a spender to saver... and downsize and get rid of the new house??? Good luck with that! Do you want to keep both or neither? :happy I kid there, but don't be so quick to get rid of the new house. IMO

why3not
Posts: 186
Joined: Wed Aug 10, 2016 12:07 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by why3not » Wed Aug 17, 2016 8:01 am

How "safe" are your jobs? If 2008/09 happens again, do either of your jobs become threatened? If your jobs are bulletproof I would attack this entirely differently than if they are at risk.

If at risk (in a severe economic downturn), I personally would be hitting the panic button today. Your wife seems "sold" on keeping the SUV so I will go with that plan. Sell the rental and car, use that $18k to pay off 401k/457 retirement loans.

Stop contributing to any retirement, take the extra $ from that + the extra $360/month (retirement loan repayment) + $500/month going into savings + whatever extra $ you have (you mention $1400) and chuck it at debt. I don't like the credit card game... again in a severe downturn, what happens when the 0% offers stop getting made? Clean those and the SUV up in under a year if possible. Then bump the retirement back up to take advantage of the match & build your emergency fund (my target guess would be $18k) and then after that is done bump retirement up to about 10% while hitting the student loans hard with everything left. At some point in there, I would look to refinance (no to very low closing costs) the house to a better rate.

If your jobs are relatively bulletproof, I would continue retirement contributions to the matched amount. I would (temporarily) stop any amount in excess of matched though. I'd still sell the car and rental and put $14k (enough to cover CC just in case the 0% runs out) into my emergency fund. Everything else goes to the SUV until that is paid off, while seeing if there is anything you can do about the student loan rate (ie: consolidate). Once the SUV was paid off, I would bump my retirement up to around 10% and focus on attacking all remaining loans (except mortgage). Again, at some point your creditworthiness should increase and I would look to refinance the mortgage at a lower rate.

I wouldn't be in a huge rush to downsize unless you have some equity you can use to hit the debt, a 1 year old + pregnancy will take up significantly more physical space in the next 5 years.

Sporkthef
Posts: 5
Joined: Thu Jun 11, 2015 3:49 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by Sporkthef » Wed Aug 17, 2016 8:17 am

Thanks for all the great advice. It seems to be pretty much in line with my plan of attacking the debt. We will keep the house at least until downsizing won't cost us. We love the house but when I run the numbers of investing that extra mortgage payment it makes me second guess. So we need to talk about our priorities in the future.

4th and Inches
Posts: 145
Joined: Mon Nov 12, 2012 8:53 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by 4th and Inches » Wed Aug 17, 2016 8:35 am

I would disregard any advice that suggests skipping the employer match to your retirement contributions. I would get rid of the rental property, keep your current house, keep the SUV, sell one of the other cars, and then get rid of the 401k retirement loan with the proceeds from the house and sold car. With what is left from selling the house I would put it in the emergency fund. Then with your extra $980 per month from being freed up from the house and 401k loan go after another debt.

Things are tight, but you will be okay.

User avatar
Watty
Posts: 11572
Joined: Wed Oct 10, 2007 3:55 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by Watty » Wed Aug 17, 2016 9:47 am

Sporkthef wrote:We will keep the house at least until downsizing won't cost us. We love the house but when I run the numbers of investing that extra mortgage payment it makes me second guess.


The house you are living in isn't the problem it is all the other loans and possibly overspending on other things each month.

The house mortgage is $1,500 a month so even if you downsized and had a $1,000 a month mortgage payment that extra $500 a month would not make a huge difference over the short or even medium term.

Excluding the rental house all the payments on the loans you listed only add up to $2,597 a month or $31,164 a year.

Your income is $113,000 so as a wild guess I think you might be paying around $25,000 a year in federal, state, and FICA taxes.

Subtracting those out leaves you with a disposable income of about $57,000. After you sell the rental house and pay off retirement accounts loans that over $60,000

You would of course need to pay for things like daycare, healthcare, pension, 401k, utilities, food, etc out of that but it looks like that is where you can make the most improvements.

orca91
Posts: 1223
Joined: Thu Mar 03, 2016 7:17 pm

Re: Getting out of my debt vs using tax advantaged space - which is better?

Post by orca91 » Wed Aug 17, 2016 11:51 am

Sporkthef wrote:Thanks for all the great advice. It seems to be pretty much in line with my plan of attacking the debt. We will keep the house at least until downsizing won't cost us. We love the house but when I run the numbers of investing that extra mortgage payment it makes me second guess. So we need to talk about our priorities in the future.


So, you should live in a shed somewhere then to have tons extra to invest. :happy

The big shiny new house has already and will cost you. How much did you pay in closing... how much will you pay in interest over a few years... how much will it cost you to sell... etc... Outside of some extraordinary appreciation over the next few years, your break even or make money point is likely more than you're thinking.

I would take the selling of the new home out of the equation. You said you love the house. Why think of selling? It will probably serve your family well for a long time. You already have it... stick with it. You have extra money each month now. You will have more each month as you knock out the smaller debts. And, you will likely get pay raises as years go by... You will have plenty extra to invest.

Don't go from saver, to spender, to saver, to miser. :happy

Post Reply