What to pay off first?

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What should boroc7 do?

Pay off the student loans first
11
41%
Pay off the student loans first
11
41%
Save/pay for wife's graduate school
2
7%
Save/pay for wife's graduate school
2
7%
Burn down the condo and collect insurance
1
4%
 
Total votes: 27

Topic Author
angelescrest
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Joined: Tue May 27, 2008 10:48 am
Location: Texas

What to pay off first?

Post by angelescrest »

I just read the Bogleheads Guide to Retirement (I'm in my early 30's), so that I could be better prepared myself, but also to better help my folks who are at retirement. Thanks to the authors!

I'm one of those unfortunate blokes who was convinced by a financial advisor to take a 5 year interest-only loan on my condo I purchased in 2005. My mortgage is at $153,000, and I've already made major prepayments to get it to that point. But still, my condo is probably only worth between $100-115k. It hurts. Thankfully this year, and probably next year won't be bad, but my adjustment rate payments are only $586 a month, and I am putting in an extra $500 a month to help pay down my mortgage.

I'm terrified in a couple years or more what the interest rates might be, and what that would do to my wife and I.

I also have $22,000 in undergrad loans at 3.375%, and $11,000 in grad loans at about 5.5%.

I'm already maxing out my Roth IRA every year and getting the match with my 403(b), and about $2500 in my wife's Roth (she's unemployed). After that, the $500 a month discretionary is about all I have to play with, although we're having our first child in a few months and I don't know how much I can keep doing that.

So I've been looking for advice on what is best to do. It's really discouraging to try to make prepayments on a mortgage that is slowly shrinking, while the value of my condo is shrinking even faster than that. Should I be paying off my graduate school loan first instead of my mortgage? Should I just be saving/investing that money instead? I hate being in debt, but paying that mortgage right now feels like trying to fuel a dying fire with my dollar bills.

My wife is also wanting to go to graduate school for a couple years to try and change careers to a field that will actually land her a job. It might cost $20,000 the whole way through. I could just pay interest on my mortgage and pay her schooling for those two years, too.

Thanks for any advice, I appreciate any words of wisdom in a challenging time.
CSAstor
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Joined: Thu Dec 30, 2010 1:41 pm

Post by CSAstor »

You didn't mention any amount of savings that you currently have, but it does sound like you're very stressed out. I think one good option would be to stock pile cash. That way you'll feel a little more comfortable and have options. You can use your pile of cash to pay off debt or pay for the school or to help out when the baby arrives (congrats!).
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JupiterJones
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Re: What to pay off first?

Post by JupiterJones »

boroc7 wrote: My wife is also wanting to go to graduate school for a couple years to try and change careers to a field that will actually land her a job. It might cost $20,000 the whole way through. I could just pay interest on my mortgage and pay her schooling for those two years, too.
I know there are plenty of people (many of whom are on this board and may respond) who see all educational debt as "good" debt. An investment, really.

I am not one of those people.

Look, you're waaaay underwater on your condo. And you're up to your eyeballs in your own student debt. And you've got a kid on the way. Your family needs more debt like a fish needs a bicycle.

Here's what I would do: Forget about the two Roths. Forget about paying extra on the mortgage. Only invest in the 403b up to the match. That will give you more extra money each month.

Take that extra money and start stocking up some serious cash reserves. If you don't already have a solid emergency fund, this will build it. If you do, this will make it bigger, which is just what you're going to want with a baby on the way.

Now I'm sure the baby will be fine and healthy, but if not, you'll be glad for the large emergency fund. Otherwise, after a bit, things will calm down and you'll begin get more of a sense of how your monthly budget will change now that junior's in the picture.

At that point, I'd start attacking the student loans, going for the small (and highest-interest) one first. Pull the emergency fund back down to do this if you feel that's a safe idea. You should have the loan knocked out in no time, eliminating one payment a month, and that will free up cash flow (which will give you more wiggle room when your adjustable rate goes up).

Investing is important, but debts are a heavy anchor.

This is all IMHO, of course. Feel free to disagree and/or ignore as you wish.

JJ
Last edited by JupiterJones on Sat Feb 26, 2011 12:03 am, edited 2 times in total.
Stay on target...
grberry
Posts: 234
Joined: Fri Jul 20, 2007 1:16 pm
Location: Boston, MA

Post by grberry »

I agree with CSAstor - having a funded emergency fund will help with sleeping at night and generally having peace of mind. You may already have this.

With a child on the way, it is also time to revisit your life insurance. (You'll probably have to wait to revisit your wife's until she is not pregnant.) The expenses that your life insurance should cover are about to go up. Revisiting this is what I would do first.

If you can eliminate the graduate loans in a year or two, I would go for them next. Right now they appear to have the highest interest rate. And eliminating them would free up some cash for other debt payments. If they cannot be paid off that fast, I would put prepayments toward the ARM.

The concern about the ARM resets may be addressable by switching to a fixed rate mortgage. Being underwater on the mortgage won't make that easy. So I don't know if it can be done, but do explore it. Maybe even get as much fixed rate as you can and another toxic mortgage to cover the rest, and then focus on repaying the toxic mortgage. If you can get even half of it to a fixed rate basis, you've taken a lot of the interest rate risk out of the picture.

On the emotion about how slowly the mortgage is shrinking, I recommend putting together an Excel spreadsheet. Have two sets of calculations, one with and one without the prepayments. The prepayments are accomplishing more than just the current shrinkage in the principal balance. They are lowering the interest due each month, thus raising the amount of principal paid each month, thus lowering the interest due the next month even more, thus .... compounding returns. I like to look at how much more principal I pay each month than the month before (first derivative of payoff) and how much that growth has grown over prior periods (second derivative of payoff). You are on a curve, and every little bit helps get you to the steep part of the curve sooner.

Also on this emotion, look back at where you were two years ago. In 45 months you have eliminated $47,000 of home debt, between the no longer existing home equity loan and the reduction in the mortgage. I know some of that probably came from the inheritance you mentioned then, but you have made good progress.

Every bit of principal prepayment is also reducing the monthly $ risk associated with a rate reset, because the new rate will be calculated on a lower amount. And the prepayments will reduce the monthly payment shock from a reset because some or all of the required increase in payments will be amounts you were already paying.

Do your best at work to deserve a raise or promotion, then ask for one. Looking for a second job to raise the income level could also help. Even if it is delivering newspapers before you go to work in the morning, additional income will help. Just don't let additional income lead to additional expense greater than the income...

Once you have a child, having two working parents normally also means having childcare expenses, even once the children are school aged. (One family of my neighbors has the husband and wife on different shifts, so that one parent is always home - but that means the parents see less of each other.) If the income from the lower income parent is not enough to cover the childcare expenses, income tax, commuting expenses, working expenses (coffee en route, uniforms/office clothing, etc...), extra meals out, extra vacation, and other associated expenses then the family would be financially better off with only one working parent. Added student loan debt would make the required income even higher. Crunch these numbers to see what level of income it would take to make the second job improve the family cash flow. Emotions and perceived quality of life could also influence the decision.
retcaveman
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Joined: Wed Oct 21, 2009 8:12 pm

Post by retcaveman »

You didn't mention the interest rate you are paying on your mortgage. Refinancing to a fixed rate is a good idea, but probably not an option if you are under water.

With a baby on the way, I would first build up a cash reserve. Then, depending upon the mortgage rate, I would either pay down the grad loans and/or the mortgage. The undergrad loan rate doesn't seem too bad. It strikes me that neither the mortgage nor the loan balances seem extreme. Neverthless, I appreciate your desire to eliminate them.

Easy for me to say, but just from a financial perspective, I would put grad school for DW on hold for a while. If she goes back to school, there may well be the added cost of child care - maybe.

Strategically, I would try to get the mortgage balance down to where you could refinance to a fixed rate loan. I share your concern about the reset rate.

Good luck.
"The wants of mortals are containers that can never be filled." (Socrates)
bdpb
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Joined: Wed Jun 06, 2007 3:14 pm

Re: What to pay off first?

Post by bdpb »

boroc7 wrote: I'm one of those unfortunate blokes who was convinced by a financial advisor to take a 5 year interest-only loan on my condo I purchased in 2005. My mortgage is at $153,000, and I've already made major prepayments to get it to that point. But still, my condo is probably only worth between $100-115k. It hurts. Thankfully this year, and probably next year won't be bad, but my adjustment rate payments are only $586 a month, and I am putting in an extra $500 a month to help pay down my mortgage.

I'm terrified in a couple years or more what the interest rates might be, and what that would do to my wife and I.
Determine what the worst case scenario is for rate increases and how that
affects your payment. Then plan this amount into your current budget.

If you current budget can handle this amount then pay off the 11k loan
with the extra 500. In less than two years this loan will be paid off freeing
up a little bit more cash flow. Then go back to paying extra on the
mortgage.

I would not stop retirement savings since your loan costs are not
all that bad. If you have been contributing to the Roths for a while then
you have an additional emergency fund all ready saved up. You can
withdraw contributions tax free at any time. You might want to lower
your stock allocation. You could take an additional amount of the Roths
and set it aside in to something less risky to act as a more secure EF.
If you really want to be safe it might make sense to fill up your wife's
Roth before paying down the loans.

If the worst case scenario hits and mortgage payment goes up beyond
what your budget can handle then lower your contributions to Roth to
make up the difference.

As much as I would never encourage your wife not to go back to school, I
think putting that on hold for a few more years might make sense. With
a new baby coming and the cost of day care it might make sense for her
to stay at home for a few more years.
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Sylvester the Investor
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Joined: Tue May 04, 2010 7:07 pm

Post by Sylvester the Investor »

Bogleheads is a good forum for sensible investment information, but for debt or credit related questions there are alot of experts at CreditBoards:

http://creditboards.com/forums/index.php?act=idx

btw you should pay off your debts in order of highest interest rate.
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celia
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Location: SoCal

Post by celia »

Congratulations on the little boglehead-to-be. I can see how this is a stressful time for you even if finances was not the issue. There's a big life change happening before your eyes. Try to enjoy it.

I agree with others that your emergency fund may not be big enough at this point. Adding to it may be your most important goal. I didn't quite understand your mortgage situation, but if you are paying off part of the principal each month, you are making progress. If the minimum you need to pay each month is $500-600, look at it as compared to rent. Would you be able to rent for that price? If not, your condo is serving you well. Even though it is now worth less than you paid for it, it provides a comfortable place for you to live and you will get money back on it when you sell. At some point you may want to refinance it to get a fixed rate.

Besides building the emergency fund, I'd recommend making payments on the mortgage principal and extra payments on the student loan with the highest interest rate. Hopefully you can get a handle on it (ie, get it to a low balance) before you take out more education loans. Maybe your emergency fund can also be used for future educational expenses, so you don't even have to take out another loan.
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Marmot
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My advice

Post by Marmot »

I like all of the feedback. I would not pay extra on mortgage at this time. I would figure out a emergency fund goal and hit it. Then I would go after the student loan with the highest interest. Once you get your emergency fund to goal, take the money you were putting into emergency fund to increase payments on student loan. Once you knock off student loan - roll that money and knock off the next loan. When you kill that student loan (I am assuming that is the next highest interest rate), use you freed up money where you want. It is very satisfying.

The mortgage is "what it is".

When we were starving students just out of school we piled up a bunch of debt. House mortgage, second mortgage for a pool, law school loans, 10K loan to parents, car loan. Yep, been there, done that. We focused on paying minimum and putting all available cash on the "weakest" loan. When we paid that off, we attacked the next, and so on. What we did not do was have an emergency fund...I agree you need that first.
JeffAL
Posts: 165
Joined: Sat Dec 05, 2009 7:32 pm

Post by JeffAL »

My wife and I just had twins last year. We spent the year before their birth saving as much cash as we could. Her paycheck for that year went directly into savings. This was huge for my peace of mind as we planned, and she did, quit work to stay at home with the babies. When you have kids you'll buy things you never even thought of before. Planning well in this regard reduces some stress after the babies arrive.

After you save up a nice pre-baby cash cushion, I'd pay off some of the student loan debt instead of paying off the mortgage.

I got burned by a condo sale a few years ago. It wasn't a lot of money but it was annoying. I've become convinced that condos are very risky buys.
Topic Author
angelescrest
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Location: Texas

Post by angelescrest »

You all are one of the best things the internet has helped create. I'm telling my wife this as she's sitting in bed next to me. And the statement of the "little boglehead to be" warms my heart, and is a nice reminder of the values of stewardship I need to instill in my daughter.

Thanks for the feedback and additional questions. I did really well last year working on the side, and with investments (probably too risky at the moment) I made an extra 40k (won't happen again) and have now $75,000 in reserves in combination of ING and in stocks in my investment account.

My condo is in the east coast and I took a job on the west coast last year. It was preventing me from switching jobs, but we paid off the heloc/mortgage part of it but unfortunately wasn't able to refinance as it dropped too much in value. I would've been thrilled if I could have had a fixed rate. This year with the LIBOR rate so low, I'm locked in until October at 3% interest-only. I doubt it'll skyrocket a great deal next year, so should be pretty low for the next 20 months, at least that's what I think. We're currently renting out our '86 condo, but we had difficulty finding a tenant before we moved and am fortunate to have one now. And we're renting cheaply in CA right now through the help of family, but that will be more difficult with a bigger family.

So we're pretty good with reserves, and those reserves thankfully leave me with options. This is our first child, and I don't know how much I need in reserves with my wife unemployed. I've always had at least 3-6 months, but I know I need more now. I was always taught that you let your investments earn you a better interest as opposed to paying off your low-interest debt (like student loans), but these days, and from your advice, maybe that's not the best way to look at it.

I already paid off about 15k of student loans in the last couple years, ones at higher interest.

I have a 30 year life insurance policy of $250,000 established a year ago, and my work kicks in another $100,000. And then there would be social security survivors benefits. This seems to be enough in my mind.

So there is the possibility to pay off some things first with my reserves, unless my reserves don't sound like they're good enough with one income. I probably wouldn't feel confused if I had a fixed rate mortgage, because while that may be at 3% now--and therefore it might make sense to pay off my 5.5% grad loan first--I'm so underwater and that 3% could go as high as 11% in the future as that's what I believe the contract maxes out at. It is tied to the LIBOR rate + 2.875%, maxing at 11%. There is that temptation (my wife doesn't share it) to just stick everything I have to get it to where I could refinance while rates are still low.
Last edited by angelescrest on Sat Feb 26, 2011 3:23 pm, edited 1 time in total.
Topic Author
angelescrest
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Joined: Tue May 27, 2008 10:48 am
Location: Texas

Re: My advice

Post by angelescrest »

Marmot wrote:When we were starving students just out of school we piled up a bunch of debt. House mortgage, second mortgage for a pool, law school loans, 10K loan to parents, car loan. Yep, been there, done that. We focused on paying minimum and putting all available cash on the "weakest" loan. When we paid that off, we attacked the next, and so on. What we did not do was have an emergency fund...I agree you need that first.
I appreciate those thoughts. I admire many people here because of how they've managed their money and where they've arrived. But being a youngin', I can tell you most of my intelligent peers are racked up in student debt unlike ever seen before. At least those of us who don't have rich folks. My in-laws tell me how they worked their way through college and didn't have any debt. That's awesome. But almost nobody can do that today with where education costs are. Even if you got paid $15 an hour, that would not go far enough. In fact, I worked full time with a decent paying job while doing my graduate work, had the best fellowship my school offered which paid half the tuition, and yet I still had to borrow money to make it work. I went into depression working so much and doing school at the same time, but that seemed the only choice I had at the time. Of course I didn't have to go to school, either, but I wouldn't have a job right now if I hadn't. These are tough times for the current and future generations trying to get through higher ed. Thanks again for the perspective.

My main takeaways are:
1. Roth (we have 50k combined) can serve as an emergency fund, although I'm hesitant to pull from that. But it's there when I need.
2. In the big debate between paying off school loans vs adjustable mortgage, I hadn't thought of it from the perspective that the money I'd free up after paying off the school loan first--which would be paid off earlier, could be used to put more into the mortgage. Even if the adjustable rate mortgage interest may be higher, I can pay off the student loan faster, so there's that element. Simple obviously, but I just hadn't thought of it that way in terms of the psychological factor.
3. Option for my wife to delay grad school. I don't know about that, but we'd have to consider it. It's not just the cost of day care, but I'm also thinking about future earning potential and her peace of mind. Not to mention the costs of grad school in the west coast are skyrocketing like you can't believe. So wait 3-4 years, and wow, it's 30% higher in some cases. No joke.
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