Author Topic: Case Study: Where to now? School Loans or New Home?  (Read 2418 times)

DeSteeg

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Case Study: Where to now? School Loans or New Home?
« on: January 20, 2014, 05:59:02 PM »
Hello Mustachians,

We've been closely monitoring our budget for the last  year or so and have dropped costs substantially.  We are looking for advice as to where to best invest our money.  We've stared at this so much that we've now decided that a mustachians eye might catch something we haven't...

Sorry there's no big interesting backstory, here's the raw data (which is what you all care about anyway ;) ):

Him (27):
Income: 75K
Debts:
Student Loans:
$6,700 @6.8%
$5,700 @ 6.55%
$3,900 @ 5.35%
$3,500 @ 2.39%

Assets:
$12,000- Vanguard  (6K in VFINX, 3K VIMSX, 3K VWNFX)
$1,500- Roth 401K (6%, employer matches 3%)
$7000- Savings Account

Her (26):
Income: 74K
Debts:
$126,000- Home ( Purchased for 162K in 2012) @ 3.75%

Assets:
$25,500- 80/20 stocks/ bonds portfolio
$8,500- Traditional IRA
$5000- Vanguard Index 500 Fund
$1000- Roth 401K (5% contribution- no matching)
$1000- Savings Account

Combined:
Monthly Spending:
Mortgage- $750 (includes property taxes and insurance)
Car Insurance- $100
Gas- $300 (2 commutes, hers is 30 miles, his is 20 miles opposite directions)
Electric & Gas- $125
Internet- $40
Spotify- $20 (better than illegally downloading)
Trash- $18
Water- $45
Food- $650
Cell phones: $100 (paying for 1 parent's phone, plus the two of us)
His Student Loans: $390
Miscellaneous- $700 (this includes anything from pet food, light bulbs, car maintenance, paint, fees for frisbee etc)
Total: $3238 ($2488 minus the mortgage payment) remainder goes towards investments about $4,000 per month. (this includes retirement contributions)

Vehicles (both are fully paid for):
2000 Hyundai Elantra: KBB $1,500
2004 Volvo XC70: KBB $7,000  (primary use for road trips and to the mtns)

Questions/ Scenarios:
1:  Buy another home: We are wondering if it would make sense to purchase another home around $300k and rent out the current house.  This would be with 5% down, no PMI, and 4.25% interest rate. The current house could get around $1600/month if we rented it out and we could buy another home closer to his work that would then allow us to go down to 1 car (sell the elantra).  This would give us around $800 over the current mortgage of the house.  Do we put that towards the new house? or pay off the rental?  or put in investment accounts?
After purchasing a home it would be possible to pay off the student loans in the following year.

2: Pay off student loans first?  This would take about a year or so, but we run the risk of rising interest rates on the purchase of a home.  This also keeps 2 cars in the household which increases costs. 

3: No house purchase, pay off student loans... but now do we pay off the current house despite the low interest rate? Or place funds in investment accounts?

Thanks for your help & advice!
« Last Edit: January 21, 2014, 08:02:28 AM by DeSteeg »

seattlecyclone

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Re: Case Study: Where to now????
« Reply #1 on: January 20, 2014, 06:21:59 PM »
I would say you should focus on getting the student loans (at least the ones over 5%) paid off this year. All your student loans are only 13% of your combined annual income, so this should be easily achievable.

You should also max out your 401(k)s at work. Your income is high enough that you would probably benefit from switching your contributions from Roth to pre-tax contributions, especially if you plan to retire early.

If you both max out your 401(k)s and pay off the student loans over 5%, that's $54,800 earmarked for those two goals this year, or less than one of your salaries. Again, this should be very feasible for you.

After that, a lot depends on your risk tolerance. Some people say you should invest in the stock market instead of paying off a low-rate mortgage since you'll do better on average in the stock market. Others say you'll probably sleep better at night and be better prepared for truly bad economic conditions (like another Great Depression) if you have your house paid off. There are valid points behind both schools of thought. I think it comes down to this: ignoring the house, would you borrow $126k at 3.75% to invest in the stock market? That's essentially what you're doing when you prioritize investing over mortgage repayment. Some people would say "Yes, 3.75% is a great deal, I'll probably earn much more than that on my investments." Other people would say "No way! The stock market is way too risky to be worth borrowing that much money." Which camp you fall into is a question we can't answer for you.

DeSteeg

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Re: Case Study: Where to now????
« Reply #2 on: January 21, 2014, 07:00:19 AM »
So would you say that the student loans are more important than the purchase of another home?  Even despite the current low interest rates?  Our fear is that the rise in interest rates will prevent us from the opportunity in the future.

Also, forgive the ignorance, but why max out the traditional 401k and not a ROTH 401k.  Can you explain the tax advantage gained by that strategy?  Also if we plan on early retirement and cannot access those funds, why would we go that route and not just invest in a Vanguard Fund?

I like the scenario that you posted comparing the risk of the mortgage to the stock market.  That is a risk we will have to debate upon.

Thanks again.

SunshineGirl

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Re: Case Study: Where to now? School Loans or New Home?
« Reply #3 on: January 21, 2014, 08:55:12 AM »
If I were in your position, I would focus this year on paying off the student loans. Just get them paid and done with. Maybe not that 2.39%, but everything else.

Then, ask your next question. A lot can happen in a year, especially at your age. Jobs can come or go, babies can happen, real estate can boom or bust, interest rates can rise or fall, work situations can deteriorate, new opportunities can come up, economies can crash or grow.

You guys are doing great! With the savings rate you have, you are well on your way to a solid financial life. I wouldn't rush into anything. Be disciplined and focused. Read as much as you can -- Your Money Or Your Life, The Great Depression: A Diary (EXCELLENT read), etc. Enjoy the simple things in life, etc.