Case Study – 32 Years Old and in Debt for the First Time

[SeattleStache]

Hey everyone.  Long time reader and finally have a question of my own to ask.

I recently bought a condo and my dad loaned me some money to reach the 20% down payment and avoid PMI.  Other than having a mortgage, this is the first time I’ve been in debt and I’m curious about how to approach it while still saving as much as possible.  Single and living in Seattle.

Gross salary: $65,000
Pre-tax savings: 12% to 401(k) ($650/month).  It was 16% before purchasing the condo but I lowered it for a couple months while I complete some renovations (blinds, heaters, and paint).  My goal is to increase it back to 16% in the next few months.  Employer matches 50% up to the first 4%.
Actual monthly take-home pay after all deductions and taxes: $3,680
Monthly Expenses:
   -Mortgage: $983.40
   -HOA: $310.61 (includes water/sewer/garbage/insurance/building maintenance)
   -Roth: $300
   -Electric: $30
   -Internet: $35
   -Dog costs (food, vet, etc): $80
   -Gas: $40 (I walk to work and just use the car for weekend trips)
   -Car maintenance: $100
   -Entertainment: $100
   -Shopping: $100
   -Groceries: $300
   -Bars/Restaurants: $200
   -Personal care (haircuts, etc): $50
   -Cell phone: n/a – fully reimbursed by employer
   -Misc: $200   
   -Car and homeowners insurance: $65
   Total: $2,844
Assets:
   -401(k): $76,392
   -Roth with Vanguard: $26,276
   -Condo: appraised at $223,000
   -Car: $3,900 (14 years old and will sell it in the next couple of years to be car-free. I don’t really consider it an asset but it’s there.)
   -Emergency cash: $3,000
   -Savings account from my grandpa: $6,000.  I pretend as though it doesn’t exist.  He passed away last year and his estate still contributes $1,000/year to the account.
Liabilities:
   -Mortgage: $176,800, 30 year, 3.99% interest
   -Personal loan from dad for down payment: $21,000, 4% interest
   -Credit card debt: none ever
Total assets less mortgage and loan: $140,768

Question: Although my dad is not putting pressure on me to repay him in a specific time frame, I would like to repay the loan as soon as possible.  Would it be best to reallocate my Roth savings to the loan repayment or is a 4% loan not worth missing out on a few years of Roth contributions?  I’m happy to clarify any information or answer any questions. Thanks in advance.

[YTProphet]

You've got a nice little emergency fund (the $3000 cash plus the $6000 in the savings) that could use maybe $3000 more worth of padding, but after that I'd just start throwing money to your dad. I think paying him $1000/month would be a good rate. You'll pay him back in about two years, which seems like a reasonable timeframe for a loan of that size. Plus, paying $1000/month seems like you're making a good faith effort to not let the loan sit around indefinitely.

[Retired To Win]

IMHO, your first order of business should be to set up an adequate cash Emergency Reserve.  With $2800 a month in expenses, $3000 in emergency cash really does not cut it.  Think more in terms of a minimum of 6 months of living expenses in a dedicated savings account reserve.  (I maintain a year's worth of expenses in a dedicated savings account.)

Ask yourself (1) how will I handle an unexpected interruption in my incoming cash flow, and (2) how long might such an interruption last?  And don't count on a best case scenario.  Emergencies are almost never that obliging.

Once you've set up that $18,000-plus reserve, you can revisit the question of who to pay when and whether to pay down debt or pump up savings.  If you don't like hearing this too much, you could argue for a six-month $12,000 reserve to backstop your necessary living expenses.

Good luck.

[MDM]

Question: Although my dad is not putting pressure on me to repay him in a specific time frame, I would like to repay the loan as soon as possible.

If that is what you would like to do, then do it.  You'll feel better, it's a relatively small amount in your overall financial picture, a guaranteed 4% return isn't terrible, etc.

You can also consider your Roth contributions to be an emergency fund, so liquidating the $6K savings to repay that amount of the dad loan seems worth doing.

[SeattleStache]

Thanks Retired To Win and YTProphet.

I suppose I subscribed to MMM's idea http://www.mrmoneymustache.com/2011/04/22/springy-debt-instead-of-a-cash-cushion/ of not keeping too much cash on hand and instead using a HELOC or, absolute worst case scenario, a Roth, to fund true emergencies.  Perhaps I misunderstood but I do like the idea of my money working for me as much as possible.  I agree that I could use a bit more cash on hand but worry about having too much that isn't working for me or being used to pay off the loan.  I could whittle my expenses down to $2,400ish in a true emergency.  I really appreciate your thoughts as I work through this!

MDM, your post came through while I was typing the above response.  Sounds like that would be similar to what I was thinking.  Do you think scaling back my Roth contributions would be smart or should I repay my dad more slowly and still contribute to the Roth?

[ioseftavi]

Hey Seattle!  Congrats on the home purchase, and on wanting to pay your dad back in a timely manner.  Sounds like you're working hard on getting a plan in place.

Now, for my suggestion:

Monthly Expenses:
   -Dog costs (food, vet, etc): $80
   -Car maintenance: $100
   -Entertainment: $100
   -Shopping: $100
   -Groceries: $300
   -Bars/Restaurants: $200
   -Personal care (haircuts, etc): $50
   -Misc: $200   
   Total: $1,130

So I try not to do "facepunches", because the last thing that online forums need is people thinking being really rude is cool.  But I will say: these categories are collectively too high, in my opinion.

As Warren Buffett said about the bonus pool, when he took the helm [briefly] at Salomon Brothers: "I don't care if you divide it up equally or give it all to one guy.  But the overall number is just too high."

Similarly, your "discretionary spending / expenses I can somewhat control" categories and amounts are not [individually] egregious.  But all added up, they're collectively too high, I think.  Somewhere in here, you can do some cutting. 

My suggestion: Try setting aside $1,660 amount for your fixed expenses (condo / HOA / roth / electrical / internet), and then give yourself $800 to spend on discretionary stuff for the month.  Doesn't matter what makes up the discretionary part.  The important thing is: don't exceed the $800. 

I bet if you structure it like that, you will find that you can suddenly cut $330 from your budget.  If it feels good after a month or two, drop your discretionary spending down to $750, and so on.

[MDM]

Do you think scaling back my Roth contributions would be smart or should I repay my dad more slowly and still contribute to the Roth?

I think you're doing well and can pick from several good alternatives.  You might consider
1) Increasing 401k and/or traditional IRA contributions at least until you get below the 25% marginal tax bracket
2) Using the $6K savings either to invest or pay toward the personal loan - flip a coin, then decide based on how you feel about the results of the flip.
3) Using the same coin flip technique to decide on the Roth vs. loan.  If you are repaying the loan at least as fast as agreed w/ your dad, and he is ok financially, he probably wants you to do what is best for you and wouldn't mind either way.

[SeattleStache]

Hey Seattle!  Congrats on the home purchase, and on wanting to pay your dad back in a timely manner.  Sounds like you're working hard on getting a plan in place.

Now, for my suggestion:

Monthly Expenses:
   -Dog costs (food, vet, etc): $80
   -Car maintenance: $100
   -Entertainment: $100
   -Shopping: $100
   -Groceries: $300
   -Bars/Restaurants: $200
   -Personal care (haircuts, etc): $50
   -Misc: $200   
   Total: $1,130

So I try not to do "facepunches", because the last thing that online forums need is people thinking being really rude is cool.  But I will say: these categories are collectively too high, in my opinion.

As Warren Buffett said about the bonus pool, when he took the helm [briefly] at Salomon Brothers: "I don't care if you divide it up equally or give it all to one guy.  But the overall number is just too high."

Similarly, your "discretionary spending / expenses I can somewhat control" categories and amounts are not [individually] egregious.  But all added up, they're collectively too high, I think.  Somewhere in here, you can do some cutting. 

My suggestion: Try setting aside $1,660 amount for your fixed expenses (condo / HOA / roth / electrical / internet), and then give yourself $800 to spend on discretionary stuff for the month.  Doesn't matter what makes up the discretionary part.  The important thing is: don't exceed the $800. 

I bet if you structure it like that, you will find that you can suddenly cut $330 from your budget.  If it feels good after a month or two, drop your discretionary spending down to $750, and so on.

Thanks!  Yes, a lot of that was an estimate as sometimes each category is less per month and other times it is more so this was based off last year's Mint data.  I like the idea of shaving off some of the spending though and will shoot for that in April.  I'm lucky to have some awesome friends who work at electricians and handypeople helping me out with lots of my projects and have been "paying" them with home cooked meals which has resulted in slightly higher grocery bills lately but totally worth it.  Any extra savings per month I will probably split between my Roth and paying dad back.  He initially said I could just pay him interest each month and then repay him in full when I sell the condo but I just don't like the feeling of owing money.

[SeattleStache]

Do you think scaling back my Roth contributions would be smart or should I repay my dad more slowly and still contribute to the Roth?

I think you're doing well and can pick from several good alternatives.  You might consider
1) Increasing 401k and/or traditional IRA contributions at least until you get below the 25% marginal tax bracket
2) Using the $6K savings either to invest or pay toward the personal loan - flip a coin, then decide based on how you feel about the results of the flip.
3) Using the same coin flip technique to decide on the Roth vs. loan.  If you are repaying the loan at least as fast as agreed w/ your dad, and he is ok financially, he probably wants you to do what is best for you and wouldn't mind either way.

I think I'll shoot for a combination of 1 and 3 while also decreasing some of my "fun" spending and throwing all extra money to my dad.  My plan is to kick up my 401k as much as possible after next month and to start maxing it out in 2016.  This was a much higher than normal spending year what with the condo purchase, even with doing all of the projects with the help of friends rather than hiring out.  Looking forward to getting back on track. Thanks again.