Author Topic: Should I save for a down payment or pay down my $20k debt?  (Read 6340 times)

SyZ

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Should I save for a down payment or pay down my $20k debt?
« on: February 27, 2016, 01:57:11 PM »
Hello, first time post here ... got a question regarding my future

Here are my vitals:

31 years old
Current salary 68k, expected to go up to 150k within about 7-8 years (yes, not a 'dream', a reality)
Single

Assets:
2011 Toyota worth about $8k
$15.5k in 401(k) - currently putting 15% into it and company matches 5% up to 80% ---> effective 19%
$5k in checking

Liabilities:
$4.4k owed on car, 1.9%
$10k student loans, 2.8%
$5.5k student loans, 6.8%

At this point, should I be saving for a home, knowing that my the 28% and 36% calculations will effectively mean there's no benefit to paying down the debt, and I can get into a home sooner and then pay off the debts after I'm in the home? Should I pay off the debts for peace of mind? Am I wrong on something?

Homes in my area are 300-500 for something I'd be comfortable with

Thanks

coolistdude

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #1 on: February 27, 2016, 02:09:11 PM »
Debt is like a leach. Pay it off when possible. House debt is a little different. If it were me, I'd at least pay off the student loans before buying a house. 300k-500k is going to take a fair amount of saving, depending on how much of a down you want. For a 300k house you are looking at a 1600+- monthly payment (depends on interest etc...). Can you just rent out a room or a small apartment? For motivation purposes, it may be worth determining the difference in FI of buying a house, vs. not buying a house.

Bracken_Joy

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #2 on: February 27, 2016, 02:12:37 PM »
Personally, I would kill that 6.8% loan. Otherwise, I would ride the other two loans. But it depends on a lot of factors, like monthly payments, time frame for moving, etc. You can always do a full case study and get some well thought out answers (see the sticky "how to write a case study").

Homes are an emotional equation as well as an economic one.

Have you seen: http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html That will answer the financial factors pretty well.

Also, MDM's famous investing order recommendation is always good to see:
Quote
WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield. (Currently 1.76%, so 6.76%)
3. Max HSA
4. Max Roth or Traditional IRA based on income level
5. Max 401k (if 401k fees are lower than available in an IRA, swap #4 and #5)
6. Fund mega backdoor Roth if applicable
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield. (Currently 1.76%, so 4.76%)
8. Invest in a taxable account with any extra.

WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs.
4. Rule of thumb: trad if current marginal rate is 25% or higher; Roth if 10% or lower; flip a coin in between
5. See #4 for choice of traditional or Roth for 401k
6. Applicability depends on the rules for the specific 401k
7. Again, take the risk-free return if high enough
8. Because earnings, even if taxed, are beneficial

GrowingTheGreen

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #3 on: February 27, 2016, 03:35:13 PM »
Here's another vote for killing the 6.8% loan.

SyZ

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #4 on: February 27, 2016, 03:40:45 PM »
Step 4 and 5 means put $18,000 into an IRA and $5,500 into a Roth?

My company offers both and the fees are like .2, very good

Putting $23,500 in when I'm currently putting 15% on 68 = $10,200, which isn't even half ... so I'd have to go from 15% saving to over 30? = /

If I did that, how would I save for a home?

Mega backdoor Roth?

Taxable account?

Regardless of that, it sounds like I should get to 7.5k checking ( a comfortable emergency fund ) and then pay off the 6.8% loan which at least keeps me busy a few months

boarder42

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #5 on: February 27, 2016, 04:08:25 PM »
Kill the 6.8 loan the other doesn't matter but counting a car as an asset is a fundamental mistake IMO.

Bracken_Joy

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #6 on: February 27, 2016, 04:25:26 PM »
Step 4 and 5 means put $18,000 into an IRA and $5,500 into a Roth?

I don't know if this is a typo or a misunderstanding, but I want to address it in case it is the latter.

You can have a Roth IRA or a traditional IRA. You can have a Roth 401(k) or a traditional 401(k). These are different types of things. The limit for the 401(k) for an individual is $18,000. The 401(k) would be offered through your employer. For the IRA, the limit is $5,500 for an individual. These are not through employers.

And for the sake of clarity: these are "buckets", not investments themselves. I think you have that concept, just wanted to verify!

Re: how will you do the house downpayment. That's a good question. 1- a lot of people around here don't see houses as very good assets, and so will say not to pursue a house until you're maxing all tax advantaged space. 2- there are rules that let you access retirement money for first time home purchase. Of note: "first time" usually just means you haven't owned a home within 2 years, I believe that applies here.

http://www.schwab.com/public/schwab/resource_center/expert_insight/ask_carrie/homes_mortgages/dip_into_ira_to_buy_first_home.html  Looks like you can pull $10k as needed, although obviously then you don't have the money in this nice tax advantaged space.

Be sure to run the rent vs buy calculator.

SyZ

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #7 on: February 27, 2016, 05:10:59 PM »
I'm only counting the car as an asset in terms of net worth calculations and things I own that contribute to my net worth

Yes, I do know the difference between the Roth and the IRA, and things like putting money into a Roth if my income will double in 10 years is better than an IRA because I'd rather be taxed at 68k than 150k

And all my retirement saving is currently through work since the rates are low, so I have both a 401(k) AND a Roth 401(k) I contribute to

Bracken_Joy

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #8 on: February 27, 2016, 05:17:55 PM »
I'm only counting the car as an asset in terms of net worth calculations and things I own that contribute to my net worth

Yes, I do know the difference between the Roth and the IRA, and things like putting money into a Roth if my income will double in 10 years is better than an IRA because I'd rather be taxed at 68k than 150k

And all my retirement saving is currently through work since the rates are low, so I have both a 401(k) AND a Roth 401(k) I contribute to

There is a lot of controversy with the roth IRA: http://www.gocurrycracker.com/roth-sucks/

It isn't a question of what your income will be doing in 10 years, but rather WHEN YOU RETIRE. That's a big difference. What will marginal rate be once you are retired is a different question =)

Anyway, I think you're using "Roth" to mean "Roth 401(k)"  and "IRA" to mean "traditional IRA". My confusion, and desire to make sure we're on the same page, is arising from that. Roth could mean IRA or 401k. IRA could mean traditional or roth. Hence my confusion =)

SyZ

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #9 on: February 28, 2016, 10:51:00 AM »
Right, but my income should theoretically be 200+ when I retire from the field I'm going into, which is much higher than where it is now. Unless you mean my income AS I'M RETIRED, as in my social security, renter's income (I can dream, right? :) ), pension (my company does still have one of these), 401(k), etc.

I am just talking about IRA and Roth IRA through 401(k)s at this point, as my company has such a low expense ratio and I just put everything in the S&P500, I don't have any accounts elsewhere. I know there are things like Vanguard funds with 25k buy ins, but I haven't seen a reason to do that

Bracken_Joy

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #10 on: February 28, 2016, 12:12:28 PM »
Right, but my income should theoretically be 200+ when I retire from the field I'm going into, which is much higher than where it is now. Unless you mean my income AS I'M RETIRED, as in my social security, renter's income (I can dream, right? :) ), pension (my company does still have one of these), 401(k), etc.

I am just talking about IRA and Roth IRA through 401(k)s at this point, as my company has such a low expense ratio and I just put everything in the S&P500, I don't have any accounts elsewhere. I know there are things like Vanguard funds with 25k buy ins, but I haven't seen a reason to do that

These are two different things. There is no such thing as an IRA in a 401(k). They are two different types of accounts. IRAs and 401(k)s are both retirement accounts, but they have different limits, rules, etc. If you want all your tax advantaged space you need to fill your 401(k) AND your IRA each year.

https://investor.vanguard.com/ira/401k-vs-ira
Numbers are outdated, but this:


So what we're saying is it's a good idea to fill all your tax advantaged space, both IRA and 401(k). Within both those account types you can choose Roth vs traditional, but it cannot exceed the limit for the account type.

Your IRA you have cpomplete control over what it is invested in- with a 401(k), you have to order off the menu- the limited choices your employer gives you. Within your IRA, you choose what it goes into- you can pick individual stocks if you want, or mutual funds, or index funds, or you can do totally different stuff- hold gold if you like, or real estate investments.

There are other advantages to IRAs over 401ks, like the way inheritance works, or access to it for buying a home. Or a Roth IRA can be used as a "super emergency fund".

Anyway, it's important to understand these are different accounts and you should be using both to maximize your financial position.

SyZ

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #11 on: February 28, 2016, 12:56:44 PM »
... now I'm a little more confused. I thought the point of a 401(k) was just to get you to invest in an IRA through your company because they'll match X% of it and nobody was investing towards their retirement so the government mandated it

So let's say I have a million dollars to invest, and I can choose between a 401(k), a Roth 401(k), an after tax 401(k) (I have something like this at work), a normal IRA, a normal Roth IRA, and a normal after-tax account

How much can I put into each, maximum?

50k 401(k), 5k IRA, 5k Roth IRA?

How much in the after-tax account?

Is there any benefit to actually controlling the individual accounts? Like, I figure if I have that level of control and power, I might as well just be a day trader - it's easier mentally to just dump in the S&P500 knowing it will get 7 ish % over my life

nobody123

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #12 on: February 28, 2016, 01:00:26 PM »
If you don't have a spouse or kids, you don't need a house.  And when the time comes, your preferences in a house today will be completely different when the spouse / kids come along anyway.

I'd aggressively kill the student loans and let the car loan go until its normal EOL since the rate is so low.  Once the student loans are gone, divert that monthly cash flow into a down payment fund.  As your income grows to your projections, you should be able to save up the $60K - $100K for a down payment in no time.

Bracken_Joy

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #13 on: February 28, 2016, 01:13:09 PM »
... now I'm a little more confused. I thought the point of a 401(k) was just to get you to invest in an IRA through your company because they'll match X% of it and nobody was investing towards their retirement so the government mandated it

So let's say I have a million dollars to invest, and I can choose between a 401(k), a Roth 401(k), an after tax 401(k) (I have something like this at work), a normal IRA, a normal Roth IRA, and a normal after-tax account

How much can I put into each, maximum?

50k 401(k), 5k IRA, 5k Roth IRA?

How much in the after-tax account?

Is there any benefit to actually controlling the individual accounts? Like, I figure if I have that level of control and power, I might as well just be a day trader - it's easier mentally to just dump in the S&P500 knowing it will get 7 ish % over my life

In IRAs, you can put $5,500 per year. This can be any combo of Roth or traditional. So you could do $3500 traditional IRA and $2000 Roth IRA. Or $5,500 traditional IRA and $0 roth IRA. They have to add to no more than $5,500.

For a 401k, YOUR contributions are limited to $18,000 per year. Same deal as above- roth or traditional, it has to add to no more than that limit. How you skew that is up to you- all in one, all in the other, something in the middle (ie, $10k in a traditional 401k, $8k in a ROTH 401k).
The $50k limit is EMPLOYER limit- your employer cannot contribute more than that on your behalf (ie, with the employer match and etc).

So as for why you would want to contribute to an IRA... well, for one, $5,500 more of tax advantaged space. If you do a traditional and qualify for the deduction (ie, don't make too much) that is $5.5k less you're being taxed on. Awesome. Or, if you qualify to contribute to a Roth IRA, you can have your investments grow tax free. Also awesome. Either way, totally worth doing.
ALSO! If you can get your AGI low enough, you can qualify for the Saver's Credit. Ex, AGI below $61k (I think it's like $37-61k, don't remember currently though) you get 10% of your IRA contribution back as a credit up to $200. That is awesome. Free money.

There are a LOT of reasons not to be a day trader. If you feel like you wouldn't be able to resist day trading because an account allows you too, I really worry about what you do with credit cards, haha. Sounds like some self regulation practice is in order!

It sounds like a read of J Collins' Stock Series is in order, SO much good info there: http://jlcollinsnh.com/stock-series/

Most importantly though, this is the part that addresses the topic at hand: http://jlcollinsnh.com/2015/06/02/stocks-part-viii-the-401k-403b-tsp-ira-roth-buckets/

Axecleaver

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #14 on: February 28, 2016, 03:59:17 PM »
Quote
At this point, should I be saving for a home, knowing that my the 28% and 36% calculations will effectively mean there's no benefit to paying down the debt, and I can get into a home sooner and then pay off the debts after I'm in the home? Should I pay off the debts for peace of mind? Am I wrong on something?
...
Homes in my area are 300-500 for something I'd be comfortable with
Just as a reality check, on 68k a year you would be approved for at most 220k, if you had $44,000 in cash for a down payment and another 6k for closing costs. And that's stretching it - the rule of thumb is 250% of your income, which at 68k would be a 175k home. A 300-500k home does not appear to be in reach for you right now.

If you decide to save for a down payment, make sure to continue contributing enough to your 401k to get all of your employer's match. That's free money.

You also seem to be operating from the perspective that debt is OK if your income will go up later. It isn't. Better to live within your means, pay off your debt ASAP (regardless of your income!) and then keep your lifestyle the same as your income goes up. You seem to be looking forward to a better lifestyle with a big house once you start making twice your income. What if, instead, you kept your expenses the same as they are now, and put all of your extra income toward retirement as your career takes off?

Metric Mouse

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #15 on: February 29, 2016, 12:22:42 AM »
so I'd have to go from 15% saving to over 30? = /

If I did that, how would I save for a home?

He asked tentatively, obviously unaware he had blundered into the Mr. Money Mustache forums....

Jacana

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #16 on: February 29, 2016, 05:36:27 AM »
...
I am just talking about IRA and Roth IRA through 401(k)s at this point, as my company has such a low expense ratio and I just put everything in the S&P500, I don't have any accounts elsewhere. I know there are things like Vanguard funds with 25k buy ins, but I haven't seen a reason to do that

Bolded an inaccurate statement. Vanguard has a LOT of funds with a far lower minimum, $3000 or even $1000. And the ETFs are no minimum, as far as I know. Same with Fidelity Spartan. So you can invest there on your own, no problem. This can be either in an IRA (5500$ yearly limit) or a regular taxable account. Good reasons to do the IRA in addition to your 401k are that it is under your control entirely, you choose the funds, and the fees are even lower because there are no 401k administrator middlemen taking their bit.

ooeei

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #17 on: February 29, 2016, 09:09:20 AM »
Hello, first time post here ... got a question regarding my future

Here are my vitals:

31 years old
Current salary 68k, expected to go up to 150k within about 7-8 years (yes, not a 'dream', a reality)

What makes this a guaranteed reality?  That seems like a very long term job guarantee...

Quote
Single

Assets:
2011 Toyota worth about $8k
$15.5k in 401(k) - currently putting 15% into it and company matches 5% up to 80% ---> effective 19%
$5k in checking

Liabilities:
$4.4k owed on car, 1.9%
$10k student loans, 2.8%
$5.5k student loans, 6.8%

At this point, should I be saving for a home, knowing that my the 28% and 36% calculations will effectively mean there's no benefit to paying down the debt, and I can get into a home sooner and then pay off the debts after I'm in the home? Should I pay off the debts for peace of mind? Am I wrong on something?

Homes in my area are 300-500 for something I'd be comfortable with

Thanks

I echo the above statements about knocking out the 6.8% loan, then saving like a madman.  One option is to leave your 401k where it is, and do a ROTH IRA as the next step ($5500/year).  The nice thing about a Roth IRA is you can take out your contributions any time without penalty. This means in 3 years if you decide to do the house thing, you can withdraw all of the money you've put into the IRA and use it for part of the down payment.

A 300-500k house for someone who so far has a net worth of approximately $0 and a salary of $70k seems a bit ambitious.  Granted, I don't know if you started with a boatload of student loans and paid them all down like a madman, and I don't know what your expenses are right now vs your savings.  For a $300k house, you'll need a down payment of ~$60,000, plus money for inspections and paperwork, and a buffer fund for repairs when you buy the house.  For now I'd recommend focusing on saving as much as humanly possible, and putting any raises you do get directly into some sort of savings.  If you're really set on the house, just max out the Roth IRA and put the rest in a normal savings or taxable account.  If you're willing to re-think the house option, consider maxing out your 401k as well.   

We may be able to give you more input if you post your current expenses and savings along with income. 

mountainstache7

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #18 on: February 29, 2016, 11:51:52 AM »
+1 on waiting to buy a home. You don't have a ton of debt and make pretty good money being single. Get 6 months of emergency fund, max out the company traditional 401k, then kill all the debt. At that point, you can re-evaluate next best steps. Can't imagine it would take very long...

JLee

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #19 on: February 29, 2016, 12:34:16 PM »
Quote
At this point, should I be saving for a home, knowing that my the 28% and 36% calculations will effectively mean there's no benefit to paying down the debt, and I can get into a home sooner and then pay off the debts after I'm in the home? Should I pay off the debts for peace of mind? Am I wrong on something?
...
Homes in my area are 300-500 for something I'd be comfortable with
Just as a reality check, on 68k a year you would be approved for at most 220k, if you had $44,000 in cash for a down payment and another 6k for closing costs. And that's stretching it - the rule of thumb is 250% of your income, which at 68k would be a 175k home. A 300-500k home does not appear to be in reach for you right now.

If you decide to save for a down payment, make sure to continue contributing enough to your 401k to get all of your employer's match. That's free money.

You also seem to be operating from the perspective that debt is OK if your income will go up later. It isn't. Better to live within your means, pay off your debt ASAP (regardless of your income!) and then keep your lifestyle the same as your income goes up. You seem to be looking forward to a better lifestyle with a big house once you start making twice your income. What if, instead, you kept your expenses the same as they are now, and put all of your extra income toward retirement as your career takes off?

I was approved for a $133k mortgage on a $140k house (with a $40k income) in 2013, and the lender told me I could've gone past $200k if I wanted to.  It's scary how much they'll loan for a house...maybe things have changed in the last 2-3 years?

mountainstache7

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #20 on: February 29, 2016, 03:26:23 PM »
I wouldn't take a banker or mortgage broker's advice on how much you can/should borrow. I would try to keep your PITI payment to 25% of  monthly take home. Less is better.

tobitonic

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #21 on: February 29, 2016, 03:31:08 PM »
Debt first, then down payment.

coolistdude

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Re: Should I save for a down payment or pay down my $20k debt?
« Reply #22 on: February 29, 2016, 06:33:40 PM »
I wouldn't take a banker or mortgage broker's advice on how much you can/should borrow. I would try to keep your PITI payment to 25% of  monthly take home. Less is better.

This. I had a realtor not understand why I was hesitant to accept a 30 year that was 40%+ monthly of my income (pre-MMM days). I don't care how nice bankers, realtors, mortgage people are. People that screw you over with money are not good people, especially when it lines their pockets.

When I was a single guy, I rented out a room. If memory serves me, it was $350/month and totally affordable for my puny jobs. I could have rented an apartment for over $700, or rented a house for $1500, or buy a house with a monthly slightly less (but bearing risk of repairs). Why spend more?