Author Topic: Case Study: Should we buy a house? High COL, student debt, newbie - help?!  (Read 3342 times)

mrs_brightside

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Hi all, I would be grateful for all input and even a few punches from the crowd. Here goes:

Just starting our FIRE journey -- to buy or not to buy a house VERY soon?

About us:
We are a married couple in our early 30s. Both of us are highly educated with student loans to match. A few years out of grad school, we’re living in East Coast City where our industry is hot and jobs are plentiful. However, cost of living is high. With real estate prices increasing close to 5%/year, and one of the lowest risk markets in the country even if the economy tanks, we were seriously considering buying soon (even with our debt). Bidding wars and open house stampedes for mediocre houses in “good school districts” have been demoralizing (exactly the kind of rat race we want to leave…).

We’ve VERY recently found MMM/FIRE and had the epiphany that we may not need to work into our 70s like our parents IF we can get into the right place with our money. But now we aren’t sure if the life we pictured in the suburbs of East Coast City are even possible if we want to get to FI. We think of ourselves as living pretty simply, we don’t shop or go out on the town much, but we’ve now found out our savings rate is not great. Feeling lost on how to proceed. Our dream would be to live on a nice, wooded piece of land in the middle of nowhere and not have to work.

Current Status:
$100k Savings + $100 401k = $200k
-$116k student loans
=Net worth $84k
The $100k savings is in a checking account (I know!!! 0.1% interest…), as a potential house down payment nest egg. We have no other accounts/investments.

Income:
Household income: $200k gross combined, a couple years into career, each of us making a similar amount. Combined take home pay is around $10,500 per month, and we are putting ~6% contribution to our 401ks with ~2-3% company match.
Monthly: Net Pay plus 401k matching = $12175

Debts:
Combined student loans of $116k. Luckily we locked in rates of <4.3% except for ~15k at 5.5%.
We’re paying everything at the minimum but maybe should increase on the high interest one(s)? We currently have around 6 years of payments left at this rate.
We spent a good bit on a wedding and dream honeymoon, which was important to us - no debts but it took a fair chunk of our earlier savings.

Transportation:
One of us drives an early 2000s Honda sedan, bought used in cash, 10 miles to work
The other takes bus/subway/walks [in the opposite direction], free with company provided pass

Monthly costs:
Rent 2400
Loans 1600 (this is the minimum payment)
Groceries/Restaurants 600 (yikes!!)
Fuel 100
Elec/Gas/Water Util. 180 average -- can double in winter 
Cell Phones 100
TV/internet/netflix 150 (another yikes!)
Personal/health/pet stuff: 150
Travel: 200
Yearly junk like AAA, etc paid in January….
-Somehow comes out to $6500 negative cash flow in Jan.

Now, our savings rate is not quite 50% if I calculated correctly. And if we bought a house, it could likely be worse:
Even with 20% down, a mortgage would probably be more like 3000/month at least.
We also might have to get a second used car or wagon that can fit our dog and hopefully soon a baby, not to mention if we move further out of town for more reasonable house price we may both need to drive to work or at least to commuter rail.

Already feeling trapped with our options...But that little voice inside our heads is saying, is all this worth an extra 5, 10, 15 years of working? On the other hand, what use is not working if we can’t live where we want or see the people we care about?

Stepping back, here are the options I see and I welcome all input:
  • Remain in our current rental, reduce dumb expenses like groceries, TV, cell service. Stay and save as much as possible even though we really don’t like the neighborhood. Schools don’t matter anyway until hypothetical kid gets older. We could also focus on paying off our loans rather than buying (BUT housing prices almost certainly continue to rise and mortgage rates increasing too).
  • Buy an ok house in a crappy neighborhood..up and coming to put it nicely. Pros: distance to work around the same or slightly shorter, mortgage slightly higher than rent but at least we’re paying for an asset with house value very likely to increase. Cons: Won’t be in a nice peaceful neighborhood, even an ok house is $400-500k
  • Buy a great house in a great neighborhood Pros: maximum satisfaction at home! Good for kids. House will not lose value, although we wouldn’t plan to sell anytime soon. Cons: commute - already 45 minutes to an hour each - will increase
  • Buy the worst/smallest house in a great neighborhood. Pros: keep the monthly housing cost close to current levels, desirable neighborhood. Cons: maybe a bad real estate idea to buy the worse house around, commute still sucks
  • Outside the box options…
    -Buy a house with in-law apt or separate living area, combine costs with in-laws (yes we all get along, they sold their house to downsize, but this would be a new arrangement…)
    -Press the reset button on our life plan. Move to Midwest City, away from our lifelong friends, but close to some family. Housing costs decrease dramatically, job prospects are worse but with a lot of effort we could probably find something similar to our current income. FIRE sooner, but maybe suffer more along the way.

If you've made it this far, what do you think?




Tuskalusa

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #1 on: February 08, 2018, 11:39:55 PM »
Hi Mrs. Brightside. Welcome to the forum. Great news that your starting to think about how to maximize your future!

Before you jump into buying a house, you might want to talk more about your long term plans. For example, do you plan to be in this city for the next 10 years?  Do you want to buy a house now and then trade up?  Do you want to hold out for your dream home?  Do you eventually want to move to the suburbs if you have kids? These are all great possibilities, and you need to figure out what’s the best one for you.

That being said, I’d recommend renting for now and tackling some of that student debt. Adding a mortgage to those student loans creates a huge amount of debt service payments. It makes you beholden to your jobs because there would be very little wiggle room. But if you knock out that debt, build a sizable down payment, and stay mindful of your spending, you maintain some freedom and flexibility.

I think you should seriously consider taking $15k from your cash reserves and pay down that higher interest student loan. Then apply your monthly savings to your remaining loans. From there, take any bonuses and divide them in half. Put half against the loan and half in savings. Avoid lifestyle inflation and bide your time.

As a Silicon Valley dweller, I understand the concern that the housing market is just going higher and higher. However, even crazy markets stall a bit when the economy slows down. The next slowdown could be your opportunity to jump into a house. You can seize that opportunity if you have a pile of cash and no debt.

I’m sure lots of folks will have awesome ideas for reducing expenses. Every dollar you save will help you move to that future goal. Good luck!

Lady SA

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #2 on: February 09, 2018, 11:50:49 AM »
DH and I are in a kind of similar boat -- lots of loans to pay off (only 1 more year, though!), rising housing market, kids on the horizon, and considering how/when/if to buy a house.

Ultimately, for you, I think you should stay put. A lot of the advice I hear is change your living situation for your current needs, not while you are anticipating what your future could look like. There is a lot that is out of your control--you might end up needing an accessible home (having a child with a disability) or not being able to have as many children as you had planned. I propose adhering to the "just enough, just in time" rule. Yes, the housing market appears to be increasing endlessly, but the housing market is cyclical. If you are patient, a deal will come along. So RIGHT NOW, what are your housing needs? Right now, you don't need a bunch of bedrooms and a backyard.

Have you seen this? https://forum.mrmoneymustache.com/investor-alley/investment-order/ I think this will be useful for you. I'd personally take $15k from your savings and pay off that higher-interest loan.

Eventually, when your kids are closer to school age, getting a house might make sense. In which case, option #4 is perfect: Buy the worst/smallest house in a great neighborhood. You mention that you worry that it might be a "bad real estate idea to buy the worse house" in a nice area--that couldn't be further from the truth. As long as the home is livable and the "bones" are sound, getting the smallest house in a nice neighborhood will net you the best of all worlds. You'll have a smaller hit to your finances but all of the benefits of the good location.

My DH and I decided to stay put in our apartment for the next few years. We are getting such a good deal on our rent that financially, it doesn't make sense to move. Also, when kids are little, they don't need much space or things, so we are planning on staying put when our kids are very young. So for the next few years we are socking away as much as we can into investments, and then later, once we have children and know what our needs are, we will start thinking about getting a house. Conveniently, right around this time we will be at least halfway to FIRE (because we will have been prioritizing investing), which relaxes a lot of need for working. We can drop down to a part-time or flexible schedule, which will make commutes much less frustrating, while our investments will grow in the background to our FIRE number.

So really, I am a fan of option #1, and then later (when it makes sense and you have outgrown your current place), option #4.

« Last Edit: February 09, 2018, 12:14:17 PM by Lady SA »

Ben Kurtz

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #3 on: February 09, 2018, 02:50:44 PM »
I'm going to join the bandwagon on this one:

Stay in a rental, maximize contributions to every tax-advantaged account you can think of (it looks like you haven't made any Roth IRA or "backdoor" Roth IRA contributions -- fix that immediately!), pay down the student loans aggressively (including, at a minimum, applying $15,000 of savings to the higher-interest one immediately), and spend a bit of time flexing your frugality muscles by trying to cut an easy $300 or so from your monthly budget (TV, food budget, energy savings, miscellaneous all look ripe). If you don't like your current neighborhood, consider moving to a similar rental in a different neighborhood which improves your commute profile -- maybe the daily driver could start riding a bike or taking the train?

Then, figure out what life has in store for you before buying the wrong house on a mere supposition. How many children do you want? This is a bit of a personal point, but seeing as the answer to that question is "more than zero" you should have a heart-to-heart with your spouse about getting started trying. Early 30s is clearly not too late to have children, but that's just the age when it starts to get harder and the timing more uncertain because of declining fertility, especially among the female half of the couple. So I'd suggest you have one child safely delivered and another in process before settling on your "forever" house.   

My usual advice for people who present in your circumstances is this: If you and your spouse both feel reasonably strongly about reaching FIRE quickly, a good financial goal is $1,000,000 in productive investments (stocks and bonds, good rental properties, etc.) and a paid off house. Having no debt service and or housing/rental expense minimizes your fixed cost base. That tends to help people sleep at night, and ride out stock market gyrations and the ups and downs of their investment portfolios. That investment portfolio can be safely assumed to support $40,000 per year of spending (plus inflation adjustments as the years go by), which for most families supports a comfortable lifestyle, though certainly not extravagant. Your family would be free of paid work; but at the same time, there is nothing stopping either parent from taking an enjoyable low-stress 1/2 time job in an enjoyable field at whatever wage one cares to accept.

Good luck!

Dee18

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #4 on: February 10, 2018, 08:00:10 AM »
With young children I found the key to a pleasant life was to live, work, and have child care all very close together.  So if I were in your situation I would not make a change that created a commute.

ShoulderThingThatGoesUp

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #5 on: February 11, 2018, 05:27:44 AM »
You don’t need a bigger place for a baby. Maybe for a bigger kid, and probably for multiple kids, but babies don’t really add to space requirements.

Long-term, though, it sounds like you’re in a place where policy makers have decided it’s only for people who can afford to stay, or can’t afford to leave. You make a good income but you’re also paying high costs. Does it make sense to stay in, I’m guessing, Boston?

chasesfish

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #6 on: February 11, 2018, 05:47:25 AM »
Welcome to the forum and the world of financial independence.    The good news is you just "feel" trapped, at $200k+ in combined income, college educated, and years ahead of you, you are anything but trapped!   I have some other comments/thoughts to add:

- You both should get your 401k contributions up to $18,500/year.  You are DINKs in a high cost East Coast area, that means you're paying state income tax too.  Its not just the match, you immediately improve your savings rate by avoiding the 30%+ in taxes.  This is urgent and immediate!

- I don't understand the $100,000 in savings and $114,000 in student loans.  What is the breakout of the student loans?  Reading this implied multiple ones, is there one you can knock out for $40,000 or $50,000?  I'm a big fan of keeping $100,000 in liquidity in taxable account, but paying off those student loans provide a guaranteed rate of return.

- Regarding the house....you should probably consider or expect to own/buy two of them.  I live in a big city and there's expensive but still comparable to rent type of housing in the city, but its not in a "good school district".   Maybe those areas are condos where you are, or maybe there's the small 1950's houses that end up being owned by all the late 20s early 30s couple with either no kids or infants/toddlers.  I think if you stay in a big city, the natural transition is to buy one of those, then make the suburb/private-school/move choice.  That's what we did after mistakenly moving to the suburbs at 25.

- There are lots of programs for first time homebuyers, you need the cash cushion for emergency/repairs.   I'm indifferent on the money down, just remember house prices don't always go up by 5%.  I remember hearing that argument too, then bought a house in 2007 that took 9 years to be worth its original value. I sold at year 7 at a $30,000 loss.

blinx7

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #7 on: February 11, 2018, 07:52:35 AM »
As someone who also just bought a house in the suburbs of what I suspect may be the same East Cost City as you recently (is there a famous internet forum where people whine about being broke on $300k incomes?), I also vote to delay as well. 

(EDIT:  I meant East Coast City, but subconsciously maybe not, lol.)

This is partly because housing prices really DON'T rise on average more than inflation.  Some places spike upwards, some places go down, preferences change, etc.  If prices are rising because of gentrification, then that means there will be a broader array of interesting neighborhoods to choose from.  (More accurately, poorer people need to leave somewhere, so what's really happening is some areas are getting fancier and others less fancy -- things are just shifting around as preferences change).  If prices are rising because East Coast City is getting more popular, eventually COL will cause things to stabilize.  For example, I would never live in a certain West Coast City because prices are just too ridiculous and all my FIRE money would be tied up in a house.  Or maybe you will catch the downturn (they do happen, really) and buy then.  Or if there is a crazy asset bubble you can just rent a while.  As long as you are somewhat flexible about neighborhood and timing then waiting is rarely going to have severe negative consequences.  I suppose the worst case scenario is that if things become permanently ridiculous like in West Coast City, then you need to move to Austin or whatever the new on-the-rise city is (there's always gonna be one). 

Waiting will allow you to not only get yourself in a better financial position (less debt, more downpayment) but you will probably make a more informed housing choice.  Your preferences are still forming, and may change as your family changes, and you will have more information about which neighborhood or house you want in a few years.  What if one you decides to change jobs and ends up with a reverse commute?  Or you have triplets (happened to a friend)?  Or you realize you aren't going to be going to bars and restaurants as much as a mustache family (hint: this is true for any family, double that for a mustache one) and decide you'd rather be near to a big park. 

I'll say also that there is a difference between what's a good boglehead decision and a good Money Mustache FIRE decision.  A few years ago, I bought a slightly over 2,000 square foot house reasonably close to both transit and highways (so that I could change jobs without changing houses) in a fancypants suburban school district right next to East Coast City.  This was a good decision for someone that wants to work a relatively high paying job they enjoy for 20 or 30 more years while raising their kids in East Coast City.  If I did want to FIRE young though, it's a bad decision because with mortgage interest, property tax, home maintenance, home insurance, home furnishing, higher utilities, etc. it increased the carrying costs of my lifestyle by probably $25k a year versus renting a two bedroom apartment and maybe by $10k a year versus a more modest neighborhood that still has decent schools (basically, a mustachian neighborhood instead of a bogleheads one).  We also drive more, although WAY less than other people despite a mediocre neighborhood walk score (bus route, bike route, local shopping one mile away, local school / church / pool / playground) but this takes some dedication (bus to subway commute for a busy professional is doable but not ideal). 

This decision will firstly delay FI but also make it very tricky RE in place, so that means I'd likely need to sell it (incurring transaction fees, disrupting family) to do that.  In retrospect adjacent neighborhood would have provided more flexibility for actual FIRE in place down the road.  I like our school options more, but I do think kids over there still get a fine education if they are motivated and many (actually probably most) of them go on to do wonderful things.  At this point, though, we've put a lot and time and money into making our house our home and so I am resistant to moving now and disrupt our family unless there's some sort  of change in life circumstances.

TL;DR -- Don't buy a house now.  If you are really committed to FIRE, stick it out in the apartment as long as possible and stack cash until you can arrange to get to somewhere cheaper.   If you decide you want to stay here and in your jobs for a reasonably long haul, crush the debt and buy later when you are ready. 
« Last Edit: February 11, 2018, 07:58:08 AM by blinx7 »

Dee18

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #8 on: February 11, 2018, 08:00:52 AM »
If you haven't already read it, look at the Frugalwoods blog, about a couple that trade their HCOL east coast city for FIRE in Vermont.  Mrs. Frugalwoods documented their journey with many great suggestions.

Laura33

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #9 on: February 11, 2018, 08:18:06 AM »
Do not buy a house.  The only reason you have mentioned for wanting a house right now is that you are afraid prices will rise and you won’t be able to afford one when you really want it.  Fear is a terrible reason for doing anything.  Focus on what you need, right now, and trust that when you need something else, you will figure out a way to do it.

You feel trapped now because you are living a high-income, high-cost life; you need that high income to keep your lifestyle going, and you feel like you need to chase even more income for all the other things you want.  But you can’t do everything all at once - no one can.  And the solution to feeling trapped is never to add on more chains - more debt, even higher monthly costs (and let’s not even talk about maintenance and upkeep), tying yourself to a town and a house you’re not even sure you want to stay in yet.

So, step one: max out both 401(k)s.  The tax breaks will allow you to put a ton more money away with less of a hit to your monthly budget.  Do this now, because the earlier you start, the more compounding you get to take advantage of.  Example:  say you have $50k in a 401(k) today.  Rule of 72 says that that money will double three times in 30 years, so by the time you are in your 60s, that money will be worth $400k.  But if you wait 10 years to start, by the time you are in your 60s, you get only two doublings, and you have $200k — half as much, just because you waited to invest the exact same amount of money.  So the earlier you start shoving vast sums into your retirement accounts, the better off you will be (and the sooner you will be there).

Step two I would say is to take some of that cash and pay off the highest-rate loan.  Then take some more and do two backdoor Roths.  This will still leave you a very significant liquid kitty.  This is the time to sit and think about what your asset allocation should be - how much you want for an emergency fund, how much stocks/bonds, etc.

And then while you are figuring that all out, do two things.  First, track your expended religiously. By next year this time, you shouldn’t be saying that “somehow” January is $6500 in the hole, because (a) you’ll know why, and (b) you’ll have fixed that.  Honestly, $6500 is a huge, gaping maw of a hole for one month, especially at your income level, which suggests your “lifestyle” expenses are higher than you think they are.  As you are tracking, you will be able to ask yourself whether what you are buying is really bringing value too you.

The second thing is to start talking to your spouse about what you want out of life.  Kids?  One of you SAH?  Stay in your area or move?  And since MMM is a new thing, take some time - months, even a year - to process what that kind of change might mean to each of you, and how much of a lifestyle change each of you is willing to change to get there.  You don’t have to figure it out all at once.

Tl;dr:  Spending money is something you do to execute the plan you developed and achieve your goals.  It is not something you do because you hope it will make you feel better and fix a problem that you don’t yet have.

blinx7

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #10 on: February 11, 2018, 08:50:06 AM »
This is a great post @Laura33.   OP you could spend thousands on a financial advisor and not get advice that good. 

Also, you need to set up a high-yield savings account and get 1.5% interest on those liquid funds STAT.  That's 1,500 on $100k.

Honestly you can probably apply most of that $100k to higher and better uses (debt repayment, Roth IRA) as Laura suggests but let's say you want to keep $50k for comfort.  That's still $750 a year. 

So with close to zero effort and no risk you can bump up your savings rate by 0.5% a year.  Every little bit adds up. 

mrs_brightside

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #11 on: February 11, 2018, 10:41:42 AM »
Thanks everyone for your extremely helpful replies. Obviously there is a lot to process and consider here, but I wanted to follow up with a couple questions while the iron is still hot.

First of all, it sounds like many of you agree that we should not buy now. Just trying to fully understand the logic here, consider this scenario. We find a house that is inexpensive enough that the monthly payment (mortgage + taxes + insurance) would be less than what we are currently paying for rent (let's say by around $500 or so). This house is certainly not our dream house, but is in a good area, has some land with it, etc., but just needs some cosmetic work that we could either put in now or over time if we decide to stay for a number of years (which is why the house is cheap for the area). Would this make sense, since we would be saving that ~$500 per month over renting and building equity? Or would it still be better to not tie ourselves to a mortgage until we pay down some loans/save more/know how we feel after having kid(s) as some have suggested?

Another question is regarding 401k. We definitely know we need to be smarter about what types of accounts we put our money into. But with a 401k, won't we be unable to access that money until we're around 60? So if we are indeed able to retire early, is there a better place to put that? I've seen some other suggestions here as well.

Thanks again for all your help. We're a bit naive in this, and are grateful to have found this community.

blinx7

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #12 on: February 11, 2018, 10:50:47 AM »
Thanks everyone for your extremely helpful replies. Obviously there is a lot to process and consider here, but I wanted to follow up with a couple questions while the iron is still hot.

First of all, it sounds like many of you agree that we should not buy now. Just trying to fully understand the logic here, consider this scenario. We find a house that is inexpensive enough that the monthly payment (mortgage + taxes + insurance) would be less than what we are currently paying for rent (let's say by around $500 or so). This house is certainly not our dream house, but is in a good area, has some land with it, etc., but just needs some cosmetic work that we could either put in now or over time if we decide to stay for a number of years (which is why the house is cheap for the area). Would this make sense, since we would be saving that ~$500 per month over renting and building equity? Or would it still be better to not tie ourselves to a mortgage until we pay down some loans/save more/know how we feel after having kid(s) as some have suggested?

Another question is regarding 401k. We definitely know we need to be smarter about what types of accounts we put our money into. But with a 401k, won't we be unable to access that money until we're around 60? So if we are indeed able to retire early, is there a better place to put that? I've seen some other suggestions here as well.

Thanks again for all your help. We're a bit naive in this, and are grateful to have found this community.

I personally think that would be fine IF you decide you are going to stick with that house for at least five years, likely closer to ten.  So basically you need to be committed to dealing with all the downsides of High Cost City because you think the upsides are worth it.  But please take a year and work through your spending (I love YNAB although not the recent price increases), learn about investing (bogleheads is actually better than here for that -- sorry guys) and FIRE (for that and for spending, this is the best) and then decide what your long term preferences and priorities are.

If you REALLY want to FIRE, move to Houston (or  insert some other city with good jobs and lower COL) and get the cheapest palatable living situation you can handle and stockpile as much money as possible.  If you are happy with a 15 or 20 year plan and really love High Cost City and your professions, then it's totally reasonable to take the slow road. 

I think a lot of the responses are a reflection of the fact that it seems like you haven't yet sorted out your preferences.  First you need to think things through, and then when you begin with the end in mind it's simpler for things to fall into place.  :)

lhamo

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #13 on: February 11, 2018, 11:12:06 AM »
IF you can find that unicorn of a house that costs less to rent than your apartment, then it might be worth considering buying now, but not at the expense of putting less in retirement. And what typically happens when people start looking is the price range keeps creeping up as they realize how much work those cheap fixer upper houses are going to be.  Not to mention if you are in a really hot market, like here in Seattle, the listing price is going to be at least 20-25% lower than the final selling price.  With the bidding wars here it is not uncommon to have to pay $100k or more over the listing price (all mostly over 500k to begin with) to get the winning bid on a house.

With your high incomes, every dollar you can put in tax deferred retirement accounts is going to save you 25-30% in taxes (real savings, because you are getting money out of the higher marginal tax brackets).  It is not a problem to put it in a 401k, because as long as you have some non-tax-deferred savings and investments to work with (say the proceeds of the sale of your HCOL area house, or other taxable acccounts, or Roth contributions), you can easily set up a Roth conversion ladder -- some good guides on how that works:

https://www.madfientist.com/how-to-access-retirement-funds-early/
http://rootofgood.com/roth-ira-conversion-ladder-early-retirement/

Mrs.MLM

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #14 on: February 11, 2018, 12:03:43 PM »
Thanks everyone for your extremely helpful replies. Obviously there is a lot to process and consider here, but I wanted to follow up with a couple questions while the iron is still hot.

First of all, it sounds like many of you agree that we should not buy now. Just trying to fully understand the logic here, consider this scenario. We find a house that is inexpensive enough that the monthly payment (mortgage + taxes + insurance) would be less than what we are currently paying for rent (let's say by around $500 or so). This house is certainly not our dream house, but is in a good area, has some land with it, etc., but just needs some cosmetic work that we could either put in now or over time if we decide to stay for a number of years (which is why the house is cheap for the area). Would this make sense, since we would be saving that ~$500 per month over renting and building equity? Or would it still be better to not tie ourselves to a mortgage until we pay down some loans/save more/know how we feel after having kid(s) as some have suggested?

Another question is regarding 401k. We definitely know we need to be smarter about what types of accounts we put our money into. But with a 401k, won't we be unable to access that money until we're around 60? So if we are indeed able to retire early, is there a better place to put that? I've seen some other suggestions here as well.

Thanks again for all your help. We're a bit naive in this, and are grateful to have found this community.

It is unlikely it will really end up being a savings of $500 a month. Expensive things, like hot water heaters and air conditioners, break and need to be replaced. I know from experience with my first home, which had a perfect inspection. A house with some land comes with yard maintenance that you may not have the time to do yourself. Even if you promise yourself that you won't care about the ugly cabinets and carpet, you are going to want to change things when you move in. Replacing the flooring alone can eat up that $500 a month for a year. Not to mention new furnishings.

Dave Ramsey says when you buy a house before you a debt-free with an emergency fund, it becomes a curse instead of a blessing and Murphy moves in the spare bedroom. My experiences confirm that. I bought my first house right out of law school when I had student loans. Every time something broke, it was stressful. The water heater flooded the garage, the air conditioner flooded the hallway, and the toilet flooded my master bedroom. Thousands of dollars. Also, I couldn't afford to change things or properly furnish it, so it was a bit depressing.

The second time I bought a house, it was when I was debt free and could easily write a check to replace the carpet and paint the interior. It was a completely different experience and it's been a blessing. Strangely, now that I have money in the bank, things hardly ever break. If they do, it's not stressful.

It sounds to me like you have house fever. I agree with the other posters who say you need to figure out your priorities and goals before you commit to such a huge purchase, epsecially when you have so much debt.

Tuskalusa

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #15 on: February 11, 2018, 12:16:34 PM »
Any house can have unforeseen problems. We bought a newer condo that seemed to be in pretty good shape, with just some cosmetic issues. Then one night, while my husband was showering upstairs, it sounded like it was raining downstairs....except it wasn’t raining. Turns out there was a plumbing issue. Good times!

The point is that you never know. There are always issues. When you rent, it’s someone else’s problem. When you own, it’s yours. So, it’s critical to have a significant emergency fund and low (or no) other debt. Otherwise, as Dave Ramsey points out, Home ownership can turn from a blessing to a curse.

When the student loans are gone, and when you have a solid savings, you will have the ability to deal with rain in your living room, or wherever else comes up. :)

newgirl

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #16 on: February 11, 2018, 12:25:06 PM »
I'm totally in your position right now - if you go to the Real Estate and Landlording thread you can find my post "Please Remind Me That I Can't Afford a House" - lots of kind folks in there can give you a reality check.

I have house fever because I despise apartment living - but ultimately what I want is the HOUSE, I don't really care if I own it or not. We already have a preferred neighborhood picked out so I have decided to limit my "house shopping" for rentals.

GizmoTX

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #17 on: February 11, 2018, 12:52:31 PM »
You only should buy when you are committed to staying there at least 10 years. As others have pointed out, you need to eliminate your debt, build an emergency fund, & max your retirement first. Take the time to figure out where you really want to be job & location wise. When you are happy with this, then go shopping. Meanwhile, rent. It doesn't have to be an apartment, & you should try house renting to see if you like house living. It also gives you a chance to figure out what floor plans & locations work for you.

chasesfish

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #18 on: February 11, 2018, 12:56:55 PM »
Thrilled you found this group, there's a lot to learn.

Google Roth Conversion Ladder, there are a ton of good writers out there that show you how to access 401k funds early.

In my experience the mortgage payment is only 70-80% of the cost of ownership.  In some cases, repairs and maintenance are as much as the mortgage payment.  The larger the house, generally the more maintenance that's required.  I owned a 20yr old dud for my first house and put almost as much toward R&M as I put into the payment.  Stuff starts breaking at 15+ years old.

Dicey

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #19 on: February 11, 2018, 01:21:54 PM »
I am pro-RE, yet I'm joining the chorus that's chanting "NO!". I think it's ill-advised to buy at the top of the market, and New Jersey property taxes are excruciatingly high. The new tax changes are not in your favor either. Take all of laura33's advice as gospel. Now is not the time for you, but with good planning, it will come.

Laura33

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #20 on: February 11, 2018, 01:27:10 PM »
Thanks everyone for your extremely helpful replies. Obviously there is a lot to process and consider here, but I wanted to follow up with a couple questions while the iron is still hot.

First of all, it sounds like many of you agree that we should not buy now. Just trying to fully understand the logic here, consider this scenario. We find a house that is inexpensive enough that the monthly payment (mortgage + taxes + insurance) would be less than what we are currently paying for rent (let's say by around $500 or so). This house is certainly not our dream house, but is in a good area, has some land with it, etc., but just needs some cosmetic work that we could either put in now or over time if we decide to stay for a number of years (which is why the house is cheap for the area). Would this make sense, since we would be saving that ~$500 per month over renting and building equity? Or would it still be better to not tie ourselves to a mortgage until we pay down some loans/save more/know how we feel after having kid(s) as some have suggested?

Another question is regarding 401k. We definitely know we need to be smarter about what types of accounts we put our money into. But with a 401k, won't we be unable to access that money until we're around 60? So if we are indeed able to retire early, is there a better place to put that? I've seen some other suggestions here as well.

Thanks again for all your help. We're a bit naive in this, and are grateful to have found this community.


On the second question, look into the Roth conversion pipeline - all you need is 5 years’ expenses in an accessible account.

On the first question, brief thoughts:

It isn’t going to be cheaper.  Add 2-4% of the home value every year for repairs/replacement.  And that doesn’t count things like lawn to mow, more square footage to clean, and higher utilities.

If you are not 100% sure you want to be there long-term, you are locking in 6-8% costs if/when you need to sell.  In a HCOL area, that is a big chunk of money.

Opportunity costs:  money sitting in a house is not in the market working for you.  In almost all areas and times, the market does better than the housing market long-term.* 

A house is largely a consumption decision, not an investment: you buy one because it provides the kind of lifestyle you want for your family.  But if you buy a house now, before you know what your future family needs are, you are either paying for extra house that you might not ever need, or buying something that fits you now even if it may be too small/in the wrong area in a few years (in which case see “6-8% transaction costs” above). 

Basically, you don’t know whether you will have kids, how many, whether you want to stay put or move, what you are going to want/need in terms of family/job/area, or even how Mustachian you guys are going to decide to be.  So how can you possibly know what size/location house is going to be right for you in 2 years or 5 or 10?  Picking the “right” long-term house right now would just be sheer luck (and even then, you’d likely still be paying extra for a few years for space you don’t need now).

*A very good life rule:  don’t rely on a plan whose success depends on you being the exception.

Ben Kurtz

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #21 on: February 12, 2018, 01:16:17 PM »
Quote
Another question is regarding 401k. We definitely know we need to be smarter about what types of accounts we put our money into. But with a 401k, won't we be unable to access that money until we're around 60? So if we are indeed able to retire early, is there a better place to put that? I've seen some other suggestions here as well.

No. Max out your 401k even if you are planning on retiring early.

Given the size of nest egg you have if you retire early, and the yearly contribution limits to 401k plans, you will inevitably end up with plenty of savings outside a 401k plans if you reach your early retirement goals. So you really don't have to spend much time worrying about the 401k restrictions. If you are just starting out on planning out a potential early retirement, don't give up the excellent tax benefits provided by qualified retirement accounts -- max them out first thing without overthinking the situation and build your non-tax-advantaged savings on top of that.

Finally, to reassure you further, I'll point out that there are two good non-mutually-exclusive strategies for accessing money in a 401k in an early retirement scenario: (1) A Roth conversion latter and (2) SEPP withdrawals.

(1) A Roth IRA is a retirement account that contains after-tax dollars. You can early withdraw contributions tax and penalty free (after all, you already paid tax on amounts contributed), but earnings are subject to taxes and penalties if withdrawn early. Direct contributions to Roth IRA accounts are not permitted by people who earn too high a salary, but there is a "backdoor Roth" technique which you ought to look up and use if it fits your circumstances. But on the subject of Roth ladders specifically: In 2010, Congress loosened the rules around converting 401k funds and regular IRA funds into Roth IRA funds, including allowing people with high incomes to make such conversions (at the time of conversion you'd treat the converted sum as taxable income and pay taxes, but you can do it as much as you want and when you want), but added a roadblock: the funds would have to sit within the Roth IRA for 5 years before they could be withdrawn penalty-free under the old "contributions can be withdrawn tax- and penalty-free" rule. The reason for this is to prevent someone from avoiding the 10% 401k early withdrawal penalty by transferring cash into a Roth IRA first for a day or a week before finally pulling it out and spending it shortly after it came out of the 401k.

A Roth conversion ladder basically sets up a continuous pipeline of yearly conversions from your 401k into your Roth IRA. Once the pipeline is in operation for more than 5 years, the first conversion ages out of the penalty and can be withdrawn freely without reference to your age -- remember, you paid tax on that first conversion 5 years early when you first made the conversion, and you're just waiting for the penalty to expire. Usually, an early retiree will start this pipeline the tax year after retirement -- as each conversion creates taxable income, it is beneficial to execute conversions once your regular salary income is gone and you are in a lower tax bracket. With this strategy, you only really need to plan for 5 years of living expenses outside a 401k.

(2) Substantially Equal Periodic Payments (SEPP): The 401k rules basically have an early retirement clause built right into them, which waives the penalties if you commit to taking taxable withdrawals every year from the year of your choosing and going forward, ending in the year you turn 59.5. An early retiree might consider invoking this clause the year after ending full time work, in order to gain access to living expenses while minimizing the income that is deemed taxable. There are various rules governing how large or how small each yearly withdrawal can be. And once you've pulled the trigger on this, you have to keep taking yearly withdrawals until you turn 59.5, at the risk of paying the 10% penalty on everything you ever took out under the SEPP program. Due to the long-term commitment and various sizing rules, this might be less attractive than a Roth conversion ladder, but it has the benefit of providing immediate access to the cash without penalty, without having to wait 5 years.

Finally, there are a few other exemptions from the penalty, such as withdrawals to meet medical and educational expenses, so even if you have a lot of money stuck in a 401k and a fairly rigid plan for moving money out in early retirement (using a Roth pipeline and SEPP), you are not completely locked in and stuck with penalties if unexpected urgent scenarios were to arise.

Dr. Dahle, at White Coat Investor, just published a post today discussing these considerations in depth: https://www.whitecoatinvestor.com/early-retirees-max-out-retirement-accounts/
« Last Edit: February 12, 2018, 01:24:06 PM by Ben Kurtz »

zeli2033

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #22 on: February 13, 2018, 08:59:50 AM »
To piggyback on what Laura33 and Ben Kurtz said, the Roth Conversion Ladder would allow you to access pre-tax funds without penalty. Here's a couple posts about those options that I thought were really helpful in grasping how to do it:

http://rootofgood.com/roth-ira-conversion-ladder-early-retirement/

https://www.madfientist.com/how-to-access-retirement-funds-early/

cchrissyy

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #23 on: February 13, 2018, 09:54:11 PM »

Basically, you don’t know whether you will have kids, how many, whether you want to stay put or move, what you are going to want/need in terms of family/job/area, or even how Mustachian you guys are going to decide to be.  So how can you possibly know what size/location house is going to be right for you in 2 years or 5 or 10?  Picking the “right” long-term house right now would just be sheer luck (and even then, you’d likely still be paying extra for a few years for space you don’t need now).


AMEN

mrs_brightside

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #24 on: February 14, 2018, 10:17:42 AM »
The only reason you have mentioned for wanting a house right now is that you are afraid prices will rise and you won’t be able to afford one when you really want it.

I'm not afraid prices will rise, I KNOW prices will rise in Massachusetts. There was no downturn even in 2008. I was also leaning towards buying after using calculators like this one: https://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html?_r=1&oref=slogin

However, I take your point that all this is predicated on intending to stay in the house for something like 10 years. We moved back to this area after being away for a while with the plan that this area was our forever home. We have been renting one single-family house or another for 8 years, and are comfortable with yard work and minor repairs etc. But with the idea of ER or at least FI just starting to rattle around in our heads, it's not a bad idea to step back from such a big decision for a while.



Dee18

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #25 on: February 14, 2018, 10:28:22 AM »
According to this chart housing prices in Boston fell by more than 25% from 2005-20012:
http://www.jparsons.net/housingbubble/boston.html

mrs_brightside

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #26 on: February 14, 2018, 11:03:28 AM »
According to this chart housing prices in Boston fell by more than 25% from 2005-20012:
http://www.jparsons.net/housingbubble/boston.html

How to reconcile this with articles like: https://www.bostonglobe.com/business/2016/01/07/think-boston-housing-expensive-now-wait-five-years/6qTjKdarDT2AdZkpqrJWaJ/story.html

Is that just a real estate PR puff piece?

I mean, your chart is showing it is clearly on its way back up and likely could be increasing for some time. 

I still struggle with paying someone else's mortgage for them while I wait for some hypothetical downturn. Maybe recent stock market declines will precipitate another decrease in prices, I don't know. But then the interest rate will increase so... lots to consider.

Clearly we made the mistake of getting emotionally invested in getting into the kind of home we want, like daydreaming about blogs like Frugalwoods. I guess it's a balance between finding inspiration/motivation from these things, and not getting discouraged from being so far away from the goal. Right now it's a lot of the latter.

mrs_brightside

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #27 on: February 14, 2018, 11:49:57 AM »
Welcome to the forum and the world of financial independence.    The good news is you just "feel" trapped, at $200k+ in combined income, college educated, and years ahead of you, you are anything but trapped!   I have some other comments/thoughts to add:

- You both should get your 401k contributions up to $18,500/year.  You are DINKs in a high cost East Coast area, that means you're paying state income tax too.  Its not just the match, you immediately improve your savings rate by avoiding the 30%+ in taxes.  This is urgent and immediate!

401k contributions: Agreed that we deserve a facepunching for this. We were confused between 401k, Roth, traditional, etc... got into analysis paralysis and did nothing more than contribute minimum amount to get company match. Plus we were saving up this down payment.

To address what you're suggesting and trying to work through the the investment order Lady SA linked, how does this look?

Going forward with our income:
0. Establish an emergency fund to your satisfaction
            OK, done.
1. Contribute to your 401k up to any company match
            Done
2. Pay off any debts with interest rates ~5% or more above the 10-year Treasury note yield.
           This would be any loans with almost 8% interest. Our max interest rate is about 5%. And yes, we each have a number of separate loans for federal vs. private and in different school years. We consolidated what we could ASAP to lock in the lowest interest rates at the time, which means the loans are not really combined year-to-year since we would have given up the earlier lower rates.
3. Max HSA
             Mr Brightside's company has high deductible insurance and funds $3k to HSA. Can/should he contribute his own money up to the maximum? I don't have any HSA - my company has traditional health plan and only has HRA (tied to them). Maybe I should jump to his insurance.
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
            This is where we got confused. My understanding is now that we have to file jointly, we make too much money combined (~200k) for Roth. Therefore, we should max out our traditional IRA up to $5500 [because there are more investment choices that are usually better and/or have lower fees].
5. Max 401k (if 401k fees are lower than available in an IRA, or if you need the 401k deduction to be eligible for a tIRA, swap #4 and #5)
            Will check on 401k fees using Personal Capital, but at a quick glance they are not great (some at 0.7%). So, we'll fund tIRA first. Will put additional funds into 401k up to whatever we need for our monthly budget or until maximum is reached.
6. Fund a mega backdoor Roth if applicable.
        Don't understand this but probably won't get this far for now.
7. Pay off any debts with interest rates ~3% or more above the 10-year Treasury note yield.         
 ????   Some of our loans fall into this category. But for peace of mind and for the sake of reducing debt before getting a house, we would like to pay all of them down faster, especially the loans at 5% interest. We plan to apply ~$15k to the 5% loans we have, then see about speeding up the others.


For existing money:
If we assume we are not buying a house for now, what to do with the $100k savings?

1. Put 3-6 mths emergency fund into high interest savings. Any thoughts on the 1.5% APY savings account called Marcus by Goldman Sachs?
2. Pay down any loans 5% or above
3. Can I put money into a traditional IRA whenever I want? Or not outside of payroll deductions? Should I use my company's IRA or open my own?
4. If we have excess funds after steps 1-3, probably invest them in Vanguard index funds. Or go for the guaranteed "4% return" on remaining loan payoff. Or leave some money for future down payment.

 


cchrissyy

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #28 on: February 14, 2018, 12:50:46 PM »
Quote
3. Can I put money into a traditional IRA whenever I want? Or not outside of payroll deductions? Should I use my company's IRA or open my own?

you can each do the full $5500 today, for both 2017 and 2018, totaling $22k of your available $100k .  this is a personal matter unrelated to your company plans. Open an account with Schwab or similar. there won't be any fees.


Ben Kurtz

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #29 on: February 14, 2018, 01:12:32 PM »
Quote
For existing money:
If we assume we are not buying a house for now, what to do with the $100k savings?

1. Put 3-6 mths emergency fund into high interest savings. Any thoughts on the 1.5% APY savings account called Marcus by Goldman Sachs?
2. Pay down any loans 5% or above
3. Can I put money into a traditional IRA whenever I want? Or not outside of payroll deductions? Should I use my company's IRA or open my own?
4. If we have excess funds after steps 1-3, probably invest them in Vanguard index funds. Or go for the guaranteed "4% return" on remaining loan payoff. Or leave some money for future down payment.

1. Let's call this emergency fund $30,000 for the sake of ease. Not familiar with that specific GS account, but anything insured by the FDIC is fine.

2. High interest student loan payoff -- that's another $15,000. You have $55,000 left to deploy.

3. Yes. IRA's are "Individual" retirement accounts -- you can't even get one through your employer. Go to Vanguard.com right now (Schwab is fine too) and open traditional, deductible IRAs -- one for yourself and one for your spouse. Each tax year you can contribute up to $5,500 per spouse. Plus, you can contribute until tax day in the name of the prior year.  So before today is finished you will transfer $22,000 from your savings to Vanguard -- $5,500 x 4 (you and your spouse, last year and this year). Put it in a low-cost target date fund and forget about it. It will probably go down next month seeing how wild the stock market has been. That doesn't matter. You only care about what it will be worth 10 or 20 years from now, not next month. When you do your joint taxes in April, take an $11,000 "above-the-line" deduction (goes right there on the 1040, doesn't require you to fill out Schedule A or give up the standard deduction) and get a big fat tax refund. Next April do the same thing.

You now have $33,000 left to deploy. I'd sleep on that for a week or a month. If you still might buy a house sooner rather than later, put it in a "short-term" muni bond fund (meaning it invests in shorter-dated more stable bonds, not that your money can only be there short term) so you can start saving up your down payment. If you decide to push out the timing on house buying then either long-term taxable investments or paying off your student loans are each legitimate options.

blinx7

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #30 on: February 14, 2018, 01:14:25 PM »
This explains the backdoor Roth.  https://www.bogleheads.org/wiki/Backdoor_Roth_IRA.  It's conceptually hard to wrap your head around at first, but once you get it, it is easy as pie.  Mine just takes a few clicks at Vanguard each year.  It also seems like no big deal for any given year but like investing generally if you do it for a long time and get good market returns it compounds and you realize in the end it was significant.

0.7 for a 401(k) is not great but the tax advantages make it worth it, particularly because you call roll it over to another employer or your own IRA if you leave your job in the future.  Also, a lot of 401(k)s have 95% junk and 5% decent funds -- I had one where everything sucked except one S&P 500 index so I put everything in that.  Or some plans have a self-directed option that you can use to avoid the junk.  So check a little more closely.   

For paying down versus investing, I'd suggest reviewing this:  https://www.bogleheads.org/wiki/Paying_down_loans_versus_investing

Personally given that stock market valuations are somewhat stretched (recent correction notwithstanding) I'd pay off at least the 5% loans.  You could consider holding a lower percentage of bonds while you are paying off the loans, so that you are still stretching for high returns in your investing while getting a better guaranteed return than most bonds can provide with your  loan payoff. 

I'd go (1) 401(k) match, (2) HSA, (3) backdoor Roth, (4) prepay 5% loan, (5) full 401(k) funding.  After that think about downpayment and house stuff.  But the loan repayment vs. investing thing is somewhat of a personal choice at the margins.

You need to be stacking a ton of cash for the mega-backdoor 401(k) stuff to be relevant.  I'd ignore that for now. 

Also, 3 months emergency fund should be fine for most people, absent unusual circumstances (single mom with dependent children and no close relatives).  If you are on good terms with your parents presumably you could crash with them if it all went to heck.  Plus you can pull contributions (but not returns) from your Roth IRA that you are setting up if you really need to.  More useful information: https://www.bogleheads.org/wiki/Emergency_fund
« Last Edit: February 14, 2018, 01:20:12 PM by blinx7 »

Laura33

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #31 on: February 14, 2018, 07:26:10 PM »
First, I am not sure you can do either a traditional or Roth IRA based on your income.  The ability to deduct a tIRA phases out at higher income levels for people who are covered by a 401(k).  And the ability to do a Roth also phases out at higher income levels (but at a different point than the tIRA phaseout - don’t you love how simple they make this?).

So I would say max out all of your tax-deductible options first and foremost.  At your income level, you are going to get huge value from the immediate deduction.  If you qualify for a tIRA, by all means, do it.  If you don’t, go right to maxing the 401(k).  And if you are concerned that analysis paralysis is going to strike again while you work through what is best, then increase the 401(k), because you can do that tomorrow at your job with minimal mental effort.

Added bonus from this approach:  being able to take that 401(k) contribution off of your income might reduce your AGI low enough to qualify for either a Roth or tIRA.

Finally, on the house thing, you are making the classic error of assuming that the future will be like the past.  Ask any long-term resident what the Boston housing market was like in the ‘80s.  Places like DC and Boston completely stagnated for a solid decade.

Note that I am not suggesting that that will happen again.  My point is rather that no one back then ever envisioned what was going to happen next.  Those of us who remember those times remember how it seemed like the slump was never going to end; we absolutely could not foresee that, for example, mortgage rates would drop from as high as 16% down to below 3% (my mortgage is 2.875% - knock me over with a feather).  So if we were smart and paying attention and doing our best to predict the future, and we were that wrong, why would you think that the future is so much more definable today?

mrs_brightside

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #32 on: February 14, 2018, 08:00:27 PM »
First, I am not sure you can do either a traditional or Roth IRA based on your income.  The ability to deduct a tIRA phases out at higher income levels for people who are covered by a 401(k).  And the ability to do a Roth also phases out at higher income levels (but at a different point than the tIRA phaseout - don’t you love how simple they make this?).

So I would say max out all of your tax-deductible options first and foremost.  At your income level, you are going to get huge value from the immediate deduction.  If you qualify for a tIRA, by all means, do it.  If you don’t, go right to maxing the 401(k).  And if you are concerned that analysis paralysis is going to strike again while you work through what is best, then increase the 401(k), because you can do that tomorrow at your job with minimal mental effort.

Added bonus from this approach:  being able to take that 401(k) contribution off of your income might reduce your AGI low enough to qualify for either a Roth or tIRA.

Finally, on the house thing, you are making the classic error of assuming that the future will be like the past.  Ask any long-term resident what the Boston housing market was like in the ‘80s.  Places like DC and Boston completely stagnated for a solid decade.

You're right, our income will prevent us from deducting a traditional IRA or contributing to a Roth IRA. We can still contribute to a tIRA but without a tax deduction. Correct me if I'm wrong, but this seems to erase any IRA advantage unless the fees are much lower.

One thing that has always been confusing to me: assuming we earn now than we will earn in retirement, we are in a higher tax bracket now than we will be in retirement. So wouldn't it be better to pay taxes in retirement than pay now? 401k and tIRA have us paying taxes later. Roth has us paying taxes now. A moot point since we can't contribute to Roth unless something major changes.

Also, I guess there may be some considerations about the future Roth IRA conversion. For example, I read that in Massachusetts converting a traditional IRA to a Roth IRA will also be subject to state income taxes. 

Ben Kurtz

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #33 on: February 15, 2018, 06:52:49 AM »
Quote
You're right, our income will prevent us from deducting a traditional IRA or contributing to a Roth IRA. We can still contribute to a tIRA but without a tax deduction. Correct me if I'm wrong, but this seems to erase any IRA advantage unless the fees are much lower.

Here is my correction:

When your high AGI prevents you from claiming the traditional IRA deduction, you are then in a position to execute the "backdoor Roth" strategy, which many people find very attractive.

@Laura33 -- good catch checking on the income point.

The backdoor Roth works this way: conversions from tIRA to Roth IRA require you to "give back" any tax advantages you had from the tIRA, so that the Roth is funded with pure after-tax dollars. If you took a deduction when contributing to that tIRA, you have to re-include the amount as taxable ordinary income in the year you convert. If the tIRA enjoyed positive returns, you have to count those returns into ordinary income as well (just like you would when you take the money out in retirement for spending). The thing is, if you made a tIRA contribution but never took the deduction (either you were lazy, or you weren't allowed to...), then when you convert to Roth there is no tax advantage to give back. Bingo -- somebody with an AGI above every IRA limit in the book all of a sudden has money in a Roth IRA! Similarly, if you invested in something that maintains a fairly stable value (like a boring bond fund), there will be minimal positive returns to count into income when you finally execute the conversion.

The "backdoor" Roth strategy is simply to do these steps deliberately: contribute to a tIRA knowing you won't get a deduction, direct the investment to something stable that won't much affect your taxes, and then after a short waiting period push the button on conversion to Roth. There has been some discussion over the years as to whether the IRS would disallow this strategy because it looked a bit sneaky, and some commentators recommend a cautious approach of making the waiting period many months long in order to create legitimate appearances that you are truly invested in the tIRA; in any event, the consensus has developed that the IRS has decided to accept this strategy and many people do it yearly (myself included -- the Vanguard website makes this very easy).

One roadblock to note is that if you have multiple tIRAs (including 401k rollover IRAs) and took deductions when contributing to some of them, you cannot "pick and choose" which contributions are converted and which are not, even if the monies are in clearly separate accounts. The IRS will require you to calculate your conversion as if you had converted a proportionate share of your deducted and non-deducted IRAs. So it is well understood that someone with existing IRAs that have pre-tax money in them cannot profitably use this strategy. When in that boat, you have to start thinking about a more complex strategy like executing a reverse rollover, which involves shuffling pre-tax money from a tIRA into an existing 401k plan that you might have (some but not all 401k plans allow such reverse rollovers), to clear the decks to allow for a successful backdoor Roth. But that's not relevant to your specific case.

So there is really no downside to using a spare $22,000 to get your IRAs up and running ASAP -- either you get the deduction, or you get a coveted backdoor Roth once you do your taxes and sort it out.

Finally, take a good long look at your 401k. Most plans these days offer at least one semi-palatable index fund investment option with fees of 0.50% or less, or at least a low cost "brokerage window" where you can buy efficient index ETFs. A half-way decent 401k plan will also have some target date funds with fees below 0.75% (ideally lower), but not all 401k plans are that great, I admit. Assuming you can find at least one good low-fee investment option, then your should definitely max out your 401k contributions going forward out of your salary deductions. That will lower your AGI and possibly qualify your for deductible IRA contributions in 2018, even if you end up having to "backdoor Roth" anything you put away in the name of 2017.
« Last Edit: February 15, 2018, 06:56:13 AM by Ben Kurtz »

Laura33

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #34 on: February 15, 2018, 07:56:23 AM »
We can still contribute to a tIRA but without a tax deduction. Correct me if I'm wrong, but this seems to erase any IRA advantage unless the fees are much lower.

One thing that has always been confusing to me: assuming we earn now than we will earn in retirement, we are in a higher tax bracket now than we will be in retirement. So wouldn't it be better to pay taxes in retirement than pay now?

1.  Yes.  But this is where the backdoor Roth comes in, as Ben Kurtz laid out.

2.  Yes.  Exactly.  That is why people here tend to recommend maxing out the 401(k) and tIRA if you can.  The Roth is beneficial largely for folks who anticipate similar tax brackets after retirement.  So for the RE crew, it is generally useful onlyafter you have filled your tax-deductible space (because it's still better to have tax-free growth and withdrawals than to just stick the money in a regular taxable account).*

*Devil is always in the details, of course, so YMMV.

mrs_brightside

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #35 on: February 22, 2018, 08:02:14 AM »
@Laura33 @Ben Kurtz @blinx7
Hi guys, I was about to pull the trigger on the traditional -> Roth IRA conversion for 2017 tax year and hit a snag. I have an old Roth account at a previous employer - will that mess things up?

I read that before you do the Roth backdoor conversion, you can't have any other IRAs with deductible contributions, because all the accounts will be combined for tax purposes and you have a problem. Please help me understand if I'm in this situation:

10 years ago I contributed to my old employer's savings plan. They had 401k option and what they called a Roth option in the savings plan. I didn't know anything about investing but I was in a low tax bracket then, so I thought contributing some to the Roth would be a good idea. All that money is still in the old company's savings plan, I have not rolled over into any personal account.

The plan says:
Quote
Roth contributions to the Plan are deducted from your paycheck after federal income taxes are withheld.... if you receive a qualified distribution, your distribution will be exempt from federal income tax....Please note that the tax rules that restrict higher paid individuals from contributing to a Roth IRA do not apply to Roth contributions in the Savings Plan or rollovers to Roth IRAs.

  • What is this weird Roth thing without any income limits?
  • Does the "Roth" portion of the company savings plan count against me for tax purposes in a backdoor Roth IRA situation?
  • If so, how do I avoid it?
  • If it doesn't count against me now, is there any way for me to ever get my $$ out of the employer savings account without messing up the backdoor Roth strategy? I was planning to move it out because it's an orphan account and I'd like to have everything in one IRA at Vanguard.
« Last Edit: February 22, 2018, 08:11:58 AM by mrs_brightside »

Ben Kurtz

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #36 on: February 22, 2018, 12:47:40 PM »
It looks like you'll be okay -- no snag on the "backdoor Roth IRA."

The language you posted sounds like you have a "Roth 401k" from a previous employer. It's a relatively less common thing, but some 401k plans contain "Roth" (meaning: after-tax) options, which basically work like Roth IRAs except there is no income limit, and you can contribute the 401k amount per year ($18,500 these days) instead of the IRA amount per year ($5,500 these days). I had one with a previous employer, but don't have access to one in my current job.

Within retirement account terminology a handy rule of thumb is: "401k" refers to retirement plans/accounts sponsored by your employer, while "IRA" refers to a retirement plan / account you set up yourself by calling a mutual fund company or brokerage firm directly. A bit of confusion comes from the fact that under certain circumstances you can take money invested in a 401k and "roll it over" into an IRA -- at that point, money in an employer plan becomes money in a personally organized plan. If you roll an existing deductible 401k into an IRA at some point in the future, you could set up a roadblock to the backdoor Roth IRA strategy (just as if you had simply opened a tIRA and contributed to it and took deductions), because the backdoor Roth IRA roadblock comes from having deductible contributions in an IRA. Lucky for you, the forgotten account that you just rediscovered is (1) not an IRA and (2) not deductible. So you're safe on two separate grounds.

You can roll a Roth 401k into a Roth IRA if you like; I'm pretty lazy about these things and don't bother rolling over accounts unless the account I would be exiting is particularly bad for some reason -- like crummy mutual funds or high fees. The only theoretical downside to this sort of rollover, to my knowledge, is that 401k plans tend to have somewhat better protection that IRA accounts in a bankruptcy / asset protection scenario. The only people who really think hard about these questions are doctors in high-risk specialties, like ob-gyns who get sued for malpractice all the time and live in fear of the day that a high-value judgment would exceed their liability insurance and result in their fancy houses and cars being taken away. You might want to do some web-searches in case there are other pluses or minuses with such a roll-over, but I can't really think of any.

In general, I'm a big fan of taking whatever tax deductions you can, but if in 2018 you'd rather keep going with the backdoor Roth IRA rather than take a deduction for a tIRA contribution and possibly gum up future backdoor Roth IRAs I think that's as fine plan as well.

RelaxedGal

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Re: Case Study: Should we buy a house? High COL, student debt, newbie - help?!
« Reply #37 on: February 28, 2018, 01:41:46 PM »
Is it a Roth 457?

I don't know what the impact of that would be vs a Roth 401k, just trying to get a handle on it.  It sounds like a strange animal.