Reader Case Study - Payoff Debt vs. Invest Quandary (Best Use of Our Money)

[chilledmonkeybrains]

Life Situation: I am 37 Married filing jointly.  My wife is 35. We have two kids (7 and 10). The 10 year old is special needs. We live in Michigan. We both live about 25 miles away from work.  With our daughter's needs, we are not interested in moving closer to our jobs as that would either land us in a much more expensive school district (housing costs) or in the city where the schooling is terrible and has almost no tailored special needs programs.

Gross Salary/Wages: I make $100,000 and my wife makes $80,000.

Pre-tax deductions: I contribute 12% to my 401k at work plus a 5% employer match.  My wife contributes 10% plus a 1% employer match.  $108/month to my FSA. Healthcare premium: $108/month

Other Ordinary Income: Small side jobs.  Roughly $1,000/year.

Qualified Dividends & Long Term Capital Gains: none.

Rental Income, Actual Expenses, and Depreciation: no rentals or depreciation.

Adjusted Gross Income: $159,700

Taxes:
Mine:
Federal: $672.19/month
FICA: $586.33/month
State: $243.09/month
Local: $33.60/month

My Wife:
Federal: $525.00/month
FICA: $468.00/month
State: $192/month

Current expenses:
Groceries: $866/month
Gas/Vehicle Maintenance:  $410/month
Property Taxes: $187/month
Cell Phones: $85/month
Gas/Electricity: $185/month
Water/Sewer: $76/month
Dining Out: $520/month (don't shoot me :) This number is stupid high, and we are packing all lunches now and eating at home as often as possible).
Insurances (Home/Auto/Life/Umbrella/Wedding Ring Set): $355/month
Tithe: $250/month
Entertainment: $60/month
Internet: $59.99/month
Health Insurance Premium: $108/month
Medicine: $20/month
Licenses: $25/month
Doctor/Dentist: $20/month
Gifts (Birthdays/Holidays/Weddings/Graduations): $163/month
Clothing: $100/month
Education/School Expenses: $15/month
Vacations: $358/month (We typically take a winter trip down South (to see the sun), and go up North a number of times over the summer)
Daycare: $593/month
Bank Fees: $2/month

Total (unless I forgot something): $4,457.99/month

Assets:
Savings Account (at credit union):  $66,000
Home: $168,000
2016 Subaru Legacy Premium: $22,500
2013 Ford Explorer XLT: 13,734 (paid off)
My 401k: $110,500 at MassMutual - They only offer one Index Fund - MM S&P 500 Index Fund (MIEYX - ER 0.47%).  All other funds are significantly higher.
Wife's 401k: $31,600 at Vanguard - She is 100% in Vanguard 2060 Target Date Retirement Fund (VTTSX - ER 0.16%). Does not have the option of VTSAX.
Previous Job 401k (rolled over at Vanguard): $24,127 (100% in VTSAX).

Liabilities: We have no credit card debt.  We have a 1st and a 2nd mortgage and one car payment (my wife uses this for traveling for work, so much of it is paid for in mileage reimbursement).
2016 Subaru Legacy $410.13/month (interest rate of 2.50%). We are currently paying $550/month on this. Balance is at $19,000.
1st Mortgage Minimum Payment $729.59/month (interest rate of 4.59%). We are currently paying $170/week on this, or $736.10/month. Balance is $104,146.
    |---> Monthly P/I:  Principal: $339.12, Interest: $396.98
2nd Mortgage Minimum Payment $253.52/month (interest rate of 6.77%). We are currently paying $277/week on this, or $1,200/month. Balance is $14,929.
    |---> Monthly P/I:  Principal: $1114.40, Interest: $85.60

Specific Question(s): Besides GREATLY reducing our dining out expenses, I'd like to ask a couple of questions...

• How aggressively should I be paying off the 2nd Mortgage (I plan to pay this off and then refi the 1st)?  Should I throw more at it a month or contribute more to investments?
• Should we be maxing out our 401ks to $18,000 each per year, or be doing something outside of our 401k's?
• How should we be preparing for the future if our daughter is unable to leave the home or retain a job? (She might be able to do these things in the future, I'm just not sure).
• Any change of approach suggestions you may have from the above.

Thanks for looking at this wall of text and any feedback you may provide :)

[Stash Engineer]

The only thing that you posted that really blew my mind (other than eating out $$, which you noted) is the fact that you have insurance on your wedding rings :o.  I also would question the amount of insurance you are carrying in general.  Do you really need to spend $100/month on clothes?  We are a family of 4 (kids 3/7) and easily spend less than $50/mo.  I realize it is only $2, but you shouldn't pay bank fees.  Ever.  There are too many no-fee banking options out there. 

I agree with you on paying off that 2nd mortgage before putting more money into 401k.  I wouldn't bother overpaying on the car, at least not until that 2nd mortgage is gone.  That extra $140/month should be paying off the 6.77% debt, not the 2.5% one.  Once you get that 2nd mortgage paid off, I'd max the 401ks. 

Since you don't know what your daughter's situation will be in the future, I would just plan for the worst case scenario (living with you as an adult?) and hope for the best.  Just keep optimizing and rock on! 

[prognastat]

Specific Question(s): Besides GREATLY reducing our dining out expenses, I'd like to ask a couple of questions...

• How aggressively should I be paying off the 2nd Mortgage (I plan to pay this off and then refi the 1st)?  Should I throw more at it a month or contribute more to investments?
• Should we be maxing out our 401ks to $18,000 each per year, or be doing something outside of our 401k's?
• How should we be preparing for the future if our daughter is unable to leave the home or retain a job? (She might be able to do these things in the future, I'm just not sure).
• Any change of approach suggestions you may have from the above.

1. I would only put the match % on your 401k if you get company match and throw the rest at the second mortgage.
2. Once you have paid off the second mortgage totally max your 401ks rather than pay off the first mortgage or car yes.
3. Since special needs is a very wide category and can mean many different things there isn't really a good way to answer this based simply on that so the best advice I can give is be realistic and if this is a big enough concern include it in any plans for FIRE.
4. Further advice:

- The vehicle gas/vehicle maintenance seems on the high side, but you've said you live far from work so that might be all it is. However if there is anything you can shave off this it could be worth it. Things like combining grocery trips to take fewer or if the store is nearby possibly instead of taking the car take a grocery trip with the family either walking or using bicycles and do the shopping that way. It helps you stay in shape and could save some money. Try seeing if you can keep it below $400 or even $390.

- The Dining out you are totally correct on preparing meals yourself you can easily get it as low as $5 per person per day if you cook smart and in large batches. Things like casseroles in the oven and crock pot meals. So for a family of 4 that would be about $600 if you home cooked all meals for the family. I would keep eating out to no more than once a week at most. This is good both financially but also health wise as generally eating out doesn't end up the healthiest. I would say try to keep groceries plus eating out under $1k a month. This would give you the $5 per person per day plus $400 for eating out per month which if used smartly should allow you to eat out once a week. This would save you about $400 a month.

- Shop around for internet. You can generally get deals on internet for $40 a month for a reasonable good connection. This is something you may have to do once they start jacking up your prices like many providers will do.

- I would see if you can at least get clothes down to below $80 per month.

- Your entertainment budget isn't huge but if you aren't already you can substitute some things for free online or at places like the library. If you have a good library nearby you might be able to get many books, movies and tv shows for free from there. You can do things such as instead of going to a cinema to watch a movie you could buy popcorn/snacks at the grocery store and pick up a DVD/BluRay from the Library and make a night out of it. Without knowing exactly what is going in to this it is hard to say if there is anything that should be cut, but it isn't so high that I think there is going to be a lot to cut here.

- If there is a decent amount of years left on the first mortgage you might want to see if you can refinance to a lower rate. Current rates are:
30 year fixed refi   4.12%
15 year fixed refi   3.23%
10 year fixed refi   3.13%
If you have a good credit score you might even be eligible for better rates than that.

If you did all of them except for the refinancing that alone would be a savings of $460+ per month/ $5520 per year. And those are post tax dollars. If instead you wanted to add that pre-tax to your 401k that would be about $6600 more you could add to 401ks annually.

[chilledmonkeybrains]

Thank you both for your replies. This is awesome information and some good guidelines for setting proper budgets for each line item. The only reason I am paying extra on the car is to stay ahead of going upside down (due to mileage).  Much of that payment is really reimbursement from my wife's employer, so "our" portion of that payment is more like $200/month.  This is also why our gas/maintenance bill is so high.  My wife frequently has to travel among her employer's different locations across our lovely state, so the gas expense is higher as result.

Can anyone suggest a good, low cost bank/credit union for a refi?  I have considered this a few times, but appraisals/closing costs/fees always seem to make the deal less appealing (at least in the short run).

Thanks again!  I'm open to anymore ideas (or ridicule/laughter directed at our current budget) :)

[prognastat]

Thank you both for your replies. This is awesome information and some good guidelines for setting proper budgets for each line item. The only reason I am paying extra on the car is to stay ahead of going upside down (due to mileage).  Much of that payment is really reimbursement from my wife's employer, so "our" portion of that payment is more like $200/month.  This is also why our gas/maintenance bill is so high.  My wife frequently has to travel among her employer's different locations across our lovely state, so the gas expense is higher as result.

Can anyone suggest a good, low cost bank/credit union for a refi?  I have considered this a few times, but appraisals/closing costs/fees always seem to make the deal less appealing (at least in the short run).

Thanks again!  I'm open to anymore ideas (or ridicule/laughter directed at our current budget) :)

Yeah the refinance is going to not help you out in the short run. I would only do it if you are able to at least shave 1% off of your APR and are still going to be stuck in your mortgage for 1/3rd or more of the original finance time.

Also depending on how high the insurance is on the rings, honestly if your rings are worth so much that you worry enough about losing them and need insurance you are probably better off getting cheaper rings for day to day wearing and storing your original rings safely and only taking them out for special occasions. You can get some really affordable bands for day to day wear and then you don't have to worry about what happens to them.

[Fiscal_Hawk]

So, just to summarize ...

Your combined take-home pay is ~10k
Your average monthly expenses are ~ 4500.

That leaves you with about 5500 per month leftover.

You should be able to knock out that second mortgage in about 3 months or so.

From there, I would max out the 401ks. Then I would max out a traditional IRA for both of you. These actions would obviously increase your 'stache and reduce your tax bill. Double win.

After that, I would look at paying off any other debts depending upon their interest rates and your attitude towards debt. You have a pretty solid base in place (retirement stash, emergency savings, etc...) so this will help towards financing any needs for the special needs child.

Finally, you can look at some ways to reduce your expenses. Specifically, the grocery bill, insurance, and cell phone plan could be looked at for possible reduction. I think you could realistically get your expenses under 4k per month and still live pretty well. Where you want to cut out expenses is up to you guys, but I don't see anything completely crazy other than the dining out expense.

[chilledmonkeybrains]

Thank you both for your replies. This is awesome information and some good guidelines for setting proper budgets for each line item. The only reason I am paying extra on the car is to stay ahead of going upside down (due to mileage).  Much of that payment is really reimbursement from my wife's employer, so "our" portion of that payment is more like $200/month.  This is also why our gas/maintenance bill is so high.  My wife frequently has to travel among her employer's different locations across our lovely state, so the gas expense is higher as result.

Can anyone suggest a good, low cost bank/credit union for a refi?  I have considered this a few times, but appraisals/closing costs/fees always seem to make the deal less appealing (at least in the short run).

Thanks again!  I'm open to anymore ideas (or ridicule/laughter directed at our current budget) :)

Yeah the refinance is going to not help you out in the short run. I would only do it if you are able to at least shave 1% off of your APR and are still going to be stuck in your mortgage for 1/3rd or more of the original finance time.

Also depending on how high the insurance is on the rings, honestly if your rings are worth so much that you worry enough about losing them and need insurance you are probably better off getting cheaper rings for day to day wearing and storing your original rings safely and only taking them out for special occasions. You can get some really affordable bands for day to day wear and then you don't have to worry about what happens to them.

I had originally planned on just continuing to kill the 2nd mortgage, and then roll a large portion of that over to the first.  I'd like to be mortgage free in less than 5 years, so it might make sense to refinance.

The ring insurance is very reasonable.  It's just a rider on our homeowner's policy and costs about $50/year, so it's not too bad.  I'll speak with my wife about picking up a less fancy daily wear band though.  Thanks for the ideas!

[robartsd]

At 6.77%, your 2nd mortgage interest rate is very close to the threshold for switching between tax advantaged savings and paying off the loan. I'd use your substantial savings account balance to pay off the 2nd mortgage and max both 2016 and 2017 IRA contributions for each of you. That leaves about $29k in savings (6+ months expenses). I'd also have your employers set your contributions to max both 401(k)s this year.

The Mortgage Professor is a great site to learn about mortgage financing. I'd start a search for refinancing there; but probably worth doing some number crunching to find out.

[chilledmonkeybrains]

So, just to summarize ...

Your combined take-home pay is ~10k
Your average monthly expenses are ~ 4500.

That leaves you with about 5500 per month leftover.

You should be able to knock out that second mortgage in about 3 months or so.

From there, I would max out the 401ks. Then I would max out a traditional IRA for both of you. These actions would obviously increase your 'stache and reduce your tax bill. Double win.

After that, I would look at paying off any other debts depending upon their interest rates and your attitude towards debt. You have a pretty solid base in place (retirement stash, emergency savings, etc...) so this will help towards financing any needs for the special needs child.

Finally, you can look at some ways to reduce your expenses. Specifically, the grocery bill, insurance, and cell phone plan could be looked at for possible reduction. I think you could realistically get your expenses under 4k per month and still live pretty well. Where you want to cut out expenses is up to you guys, but I don't see anything completely crazy other than the dining out expense.

This seems like a very logical approach and seems to go along with what I have been thinking.  My only question is about the suggestion to use a traditional IRA after capping out our 401k contributions.  Don't we at least partially or completely lose the ability to deduct the traditional IRA contributions based on our income (I'll have to look up the limits again)?

Thank you for the insight! 

[chilledmonkeybrains]

At 6.77%, your 2nd mortgage interest rate is very close to the threshold for switching between tax advantaged savings and paying off the loan. I'd use your substantial savings account balance to pay off the 2nd mortgage and max both 2016 and 2017 IRA contributions for each of you. That leaves about $29k in savings (6+ months expenses). I'd also have your employers set your contributions to max both 401(k)s this year.

The Mortgage Professor is a great site to learn about mortgage financing. I'd start a search for refinancing there; but probably worth doing some number crunching to find out.

What a great bunch of replies!  Thank you.  This seems like a great idea.  My only question is about our ability to deduct the IRA contributions based on our income, but maybe that is not an issue.

[prognastat]

So, just to summarize ...

Your combined take-home pay is ~10k
Your average monthly expenses are ~ 4500.

That leaves you with about 5500 per month leftover.

You should be able to knock out that second mortgage in about 3 months or so.

From there, I would max out the 401ks. Then I would max out a traditional IRA for both of you. These actions would obviously increase your 'stache and reduce your tax bill. Double win.

After that, I would look at paying off any other debts depending upon their interest rates and your attitude towards debt. You have a pretty solid base in place (retirement stash, emergency savings, etc...) so this will help towards financing any needs for the special needs child.

Finally, you can look at some ways to reduce your expenses. Specifically, the grocery bill, insurance, and cell phone plan could be looked at for possible reduction. I think you could realistically get your expenses under 4k per month and still live pretty well. Where you want to cut out expenses is up to you guys, but I don't see anything completely crazy other than the dining out expense.

This seems like a very logical approach and seems to go along with what I have been thinking.  My only question is about the suggestion to use a traditional IRA after capping out our 401k contributions.  Don't we at least partially or completely lose the ability to deduct the traditional IRA contributions based on our income (I'll have to look up the limits again)?

Thank you for the insight!

Someone with more experience with IRAs might have to chime in own this one, but if you both max your Traditional 401k's that would drop down your AGI by 36k and it would only be $144,000 a year.

Another option after you pay off the second mortgage and max your traditional 401ks for both of you is to see if either of your employers retirement plans support after tax deposits. If so you could do a "Mega backdoor Roth" to add money to a Roth IRA above the limits allowed for regular deposits.

[chilledmonkeybrains]

So, just to summarize ...

Your combined take-home pay is ~10k
Your average monthly expenses are ~ 4500.

That leaves you with about 5500 per month leftover.

You should be able to knock out that second mortgage in about 3 months or so.

From there, I would max out the 401ks. Then I would max out a traditional IRA for both of you. These actions would obviously increase your 'stache and reduce your tax bill. Double win.

After that, I would look at paying off any other debts depending upon their interest rates and your attitude towards debt. You have a pretty solid base in place (retirement stash, emergency savings, etc...) so this will help towards financing any needs for the special needs child.

Finally, you can look at some ways to reduce your expenses. Specifically, the grocery bill, insurance, and cell phone plan could be looked at for possible reduction. I think you could realistically get your expenses under 4k per month and still live pretty well. Where you want to cut out expenses is up to you guys, but I don't see anything completely crazy other than the dining out expense.

This seems like a very logical approach and seems to go along with what I have been thinking.  My only question is about the suggestion to use a traditional IRA after capping out our 401k contributions.  Don't we at least partially or completely lose the ability to deduct the traditional IRA contributions based on our income (I'll have to look up the limits again)?

Thank you for the insight!

Someone with more experience with IRAs might have to chime in own this one, but if you both max your Traditional 401k's that would drop down your AGI by 36k and it would only be $144,000 a year.

I was just looking at this chart https://www.nerdwallet.com/blog/investing/ira-contribution-limits/ which makes it look like at $118,000 there is no deduction available.  But, will have to look at my taxes from last year and see what my true modified adjusted gross income looked like.  My 401k plan does support Roth contributions, so that would be an option as well (I'll have to check my wife's plan). Thanks again :)

[prognastat]

So, just to summarize ...

Your combined take-home pay is ~10k
Your average monthly expenses are ~ 4500.

That leaves you with about 5500 per month leftover.

You should be able to knock out that second mortgage in about 3 months or so.

From there, I would max out the 401ks. Then I would max out a traditional IRA for both of you. These actions would obviously increase your 'stache and reduce your tax bill. Double win.

After that, I would look at paying off any other debts depending upon their interest rates and your attitude towards debt. You have a pretty solid base in place (retirement stash, emergency savings, etc...) so this will help towards financing any needs for the special needs child.

Finally, you can look at some ways to reduce your expenses. Specifically, the grocery bill, insurance, and cell phone plan could be looked at for possible reduction. I think you could realistically get your expenses under 4k per month and still live pretty well. Where you want to cut out expenses is up to you guys, but I don't see anything completely crazy other than the dining out expense.

This seems like a very logical approach and seems to go along with what I have been thinking.  My only question is about the suggestion to use a traditional IRA after capping out our 401k contributions.  Don't we at least partially or completely lose the ability to deduct the traditional IRA contributions based on our income (I'll have to look up the limits again)?

Thank you for the insight!

Someone with more experience with IRAs might have to chime in own this one, but if you both max your Traditional 401k's that would drop down your AGI by 36k and it would only be $144,000 a year.

I was just looking at this chart https://www.nerdwallet.com/blog/investing/ira-contribution-limits/ which makes it look like at $118,000 there is no deduction available.  But, will have to look at my taxes from last year and see what my true modified adjusted gross income looked like.  My 401k plan does support Roth contributions, so that would be an option as well (I'll have to check my wife's plan). Thanks again :)

Oh they aren't Roth contributions, they are after tax contributions. It sounds like it is the same, but it isn't. These don't count towards the 18k limit and can be rolled over to a Roth IRA outside of your retirement account. However many employer 401k plans don't offer this option so it might not be an option.