Author Topic: CASE STUDY:Invest? Pay off mortgage?  (Read 4940 times)

fionn

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CASE STUDY:Invest? Pay off mortgage?
« on: March 02, 2015, 06:09:11 PM »
My wife did most of the writing below. I'll try to consolidate the text when time permits. One thing to add is that as a teacher in Texas, I pay into the Teacher Retirement System. Our district also offers a 403b matching program, giving a 1% match contingent upon perfect attendance. As for investing our savings, I'm personally looking at doing a 90/10 stock/bond split with a Vangaurd index fund, putting 100k into it and leaving about 30k in the savings account for liquid cash. My wife feels more comfortable with 80k in the fund and 50k in savings. We don't have a set retirement age; most likely when my teacher pension kicks in at age 57, but we both hate not working. Oh, and our multiple bank accounts will be consolidated soon into a single checking and savings (they drive me crazy).

See below for her question--


Question: How should we invest a lump sum of cash? Are we paying off our mortgage efficiently?
Income:
Husband (29) teacher - 50k
Wife (28) technical writer - 48,800 + quarterly bonuses = 53k
Married 6 years, first baby due in September

Average Net monthly take home pay:
Husband: $3430
Wife: $2932 (health insurance and 7% towards 401k taken out of check)
Extra income: $100 a month (Husband side project)
Average total: $6462
Months with quarterly bonus check: extra $1500

Only debt: Mortgage ( we owe $124,963)
5% interest rate
Purchased home in 2009 for $146,900
FHA loan for $141,997

Spending:
Mortgage: $1237 (includes taxes and home insurance) (taxes are expensive, about $3500 a year)
Utilities: $200-300
Cell: $45
Car insurance: $100
Gas: $200
Groceries/eating out: $500
Cable/internet: $137
OBGYN payments: $465 until June
Netflix/Spotify: $18
Savings: $1400
Tithing: $540
Extra Principle Payment to mortgage: $800
Leftover $770 (half sits in the checking account as a buffer and the other half we spend on misc. expenses)

Assets:
Main savings account: 130k
Main checking acct: $1000-3000 (this varies as we pay our bills from here)
Way to Save account $1200 (every time a debit is made from the checking account, a dollar is transferred to this account. We use this account for emergencies)
Extra Checking acct: $2200
Extra Savings acct: $4000
Extra Savings acct: $1600
Total cash assets: 141k

Wife's 401k: 32k (company matches 100% up to 5%. Currently contributing 7%)
Husband's Roth IRA: $15,500

In our early twenties we got married, bought a house, and didn't know much about money other than to save as much as possible. We have saved a lot of cash but now we realize we are losing money to inflation as it's just sitting in our savings account. What is the best way to invest a large amount of cash? How much should we invest? We are thinking 80k so we have a large emergency fund if we need it. We are also wondering about what taxes you pay if you want to access your cash investment. We don't plan on touching it but would like to know in case of an emergency.
Note: We are taking 11k and putting half in the husband's roth IRA and starting a roth IRA for the wife.

We would like to pay off our house in the next seven years so we are making large extra principle payments every month. We don't know if this is the most efficient way to pay off the house. We have considered refinancing to a 15 year loan but using an online calculator it looks like we'd pay off the house in the same amount of time as making the extra principle payments. We are seven months away from getting the PMI dropped.

Monthly Spending: Looking at the budget, we can do better. We want to cut cable and do better with our miscellaneous expenses.








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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #1 on: March 02, 2015, 06:34:33 PM »
You've done a great job of piling up cash, considering you're not even 30 yet.

Here's my top recommendation for you: take $30,000 and set it aside in a savings account as an Emergency Reserve that will cover one year of your basic living expenses (minus saving, tithing, extra mortgage payment).  Having that backstop will "liberate" you to be able to invest the rest of your cash without (too much) trepidation.

This little tactic has worked very well for my mental peace of mind.  I've had that one year of basic living expenses stashed away now for years. And I sleep very well at night, even with all the rest of my money in the stock market.  :O

darkcait

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #2 on: March 02, 2015, 06:42:35 PM »
Just an idea, but you could set aside a 3-6 month emergency/baby fund, max out Roth IRAs for the two of you for 2014 and 2015, and then apply the rest towards your mortgage. Honestly, if it were me I would be tempted to just pay off the mortgage entirely and free up the $900 or so per month that you may in principal and interest. That would also lower your expenses enough that one of you could probably stay home or go part time if you wanted to when the baby comes.

el_beardo

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #3 on: March 02, 2015, 06:49:07 PM »
why do you still have the mortgage at 5% ? were you unable to refi during the recent low interest period ?

Given that you kept your mortgage at 5% any additional money you put against principal does guarantee you a ~5% return.

I've always thought that if I held the entirety of my mortgage debt in cash assets that I would pay it off. If you guys did that you would be free-ing up an additional 2k per month. But you would be out your cash savings.

Have you looked into maxing out your retirement accounts ? Two person household means you can send out 36k per year, do that now while your young and it will compound tax free for a long time.

fionn

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #4 on: March 02, 2015, 07:00:36 PM »
Thanks for the replies.

Those were some of the issues that we were personally debating:

1) for the mortgage, we originally had to get an FHA loan since we were first-time homebuyers. We've only recently begun the extra principal payments. The reason why we've held off a refi is that we're afraid that the costs associated vs. amount saved would be roughly equal to paying our current mortgage off within the next few years. Could someone chime in with other advice?

2) If we were to pay it off in a lump sum, that would leave less to put down now to compound. Wouldn't 100k invested now at ~8% earn much more than 20k/yr over the next 5 years?

We would like to invest as much as possible into the retirement accounts, but also put some into a more accessible means, as we're looking to do some minor reno to our current house to allow two kids' bedrooms while keeping us at the same property (we plan to camp out here for a while as our area is going through a real estate boom for the next foreseeable decade).

gomike

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #5 on: March 02, 2015, 07:04:31 PM »


1) for the mortgage, we originally had to get an FHA loan since we were first-time homebuyers.

No you didn't. 

fionn

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #6 on: March 02, 2015, 07:57:18 PM »


1) for the mortgage, we originally had to get an FHA loan since we were first-time homebuyers.

No you didn't.

We were young and dumb, newly weds, both with very little credit, and only one stable income at the time. Our realtor was our only advice. We didn't know any better.

Hayden Frys Mustache

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #7 on: March 02, 2015, 08:37:28 PM »


1) for the mortgage, we originally had to get an FHA loan since we were first-time homebuyers.

No you didn't.
Our realtor was our only advice.

Realtors....

I feel for ya

fartface

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #8 on: March 02, 2015, 08:42:58 PM »
First, use $125,000 to Kill the Mortgage. You won't regret it.

Next, take $10,000 and open your Vanguard Brokerage account. Buy VTSAX or VDADX (Admiral shares).

Keep $5000 in GE Capital Bank (it earns 1.05% interest) for savings/emergency fund.

Start depositing the 'would be' house payment + monthly surplus into
 1. Vanguard Brokerage account
 2. GE savings if it makes you feel better
 3. 529 for Jr.

If some catastrophic expense comes along, and you need to, open a HELOC (probably around 3% interest currently).

Through monthly dollar-cost-averaging at your age you smooth out the stock market swings.

I was in a similar situation about a year ago. We received a check at closing for $200K after selling a rental property.

Over the course of the next year we:
 +used $150,000 to pay off mortgage
 +funded our 2013, 2014, 2015 Roth IRA's = $33,000
 +funded the 529 up to max tax deduction in our state {$3K/year} = $9000
 +kept $8000 in cash savings

This allowed me to free up $$$ and I:
+opened our Vanguard Brokerage account which now sits @ $55,000
+increased my 403b contributions to $1450/month & current 403b balance = $50,000
+purchased my other daughter a custodial DRiP for $10,000
+increased cash savings to $10,000

As you can see...by paying off your mortgage in short order, you'll be able to fund your other investments to the tune of $2000-$3000 OR MORE every month. This amount will grow quickly, and like I said earlier, protect you better from the wild market swings.

Well, good luck to you!

SaintM

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #9 on: March 02, 2015, 08:43:30 PM »
1.  Definite refi.  You could probably go down to a 15 year loan at 3%.  You are looking at paying $80 more a month and knocking almost 10 years off the combined term.  If your neighborhood has truly appreciated, an appraisal associated with the refi may get your LTV below the PMI threshold.

2.  You don't need $30k sitting in cash, much less $50k or $141k.  Cash loses purchasing power, so you need to get that money to work.  The prevailing view on here is Vanguard index funds.  It's not for everyone, but if you don't know investing, don't go any other route.  Learn the basics, first.  There is plenty of info on this site and links to other useful info.

feelingroovy

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #10 on: March 02, 2015, 09:12:51 PM »
First, you guys rock!  What a great position to be in.

I do think Fartface has a good plan, and if that makes you and/or your wife feel more secure, do it.  To optimize though, while still staying somewhat "safe" this is what I would do:

1. Put enough cash toward the mortgage to get you to 80% LTV, then refinance to a 15 yr mortgage at a lower interest rate.  Do not prepay it.  Your interest rate will be so low.   Why did you pick 7 years? 

2. Immediately maximize both your 403B and your wife's 401k.  This is really going to be the basis for your stash.  (You could also do it incrementally if it makes you nervous).

Both these steps will lower your monthly cash flow.  I would just sit on the rest of the cash for a few months after you've done this while you adjust.  If you do too much at once, you'll freak out.  You do have enough cash flow for it, however.

3. Once you feel comfortable with your new reality, pick an amount for the emergency fund then invest the rest in a taxable Vanguard acct.  More than 12 months living expenses is really unnecessary.  Even that much is unlikely to ever be necessary, but this is pretty personal.  Especially with a baby on the way.  I am definitely one who feels better with cash in the bank and I'm old enough to have seen emergencies happen.  Even so, I'm comfortable with a $20k cash EF.

fionn

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #11 on: March 02, 2015, 09:15:37 PM »
100k lump sum invested for 5yrs with a 7% return=140,255.17

20k/yr invested yearly for 5yrs with a 7% return=123,065.81

Third DCA option: 100k lump sum invested for 5yrs with ~10k added each year as budget allows, 7% return=187,762.56

Please correct me if I'm wrong, but doesn't the third option generate a better return? I understand that we're dealing with the 5% mortgage, but I'd rather have that safety net than blow the majority of our savings to eliminate the mortgage. Also, what difference would refinancing fees be versus the interest saved by simply paying off our current loan in 7 yrs?
« Last Edit: March 02, 2015, 09:41:22 PM by fionn »

fionn

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #12 on: March 02, 2015, 09:24:04 PM »
1. Why did you pick 7 years? 

2. Immediately maximize both your 403B and your wife's 401k.  This is really going to be the basis for your stash.  (You could also do it incrementally if it makes you nervous).


1. It was an arbitrary goal where we could be happy with the increased payment/reduced principal. Although I understand your reasoning. Banks like the good LTV ratio and it'll help us get a better rate. Awesome advice. Thanks!

2. I'd probably only do 1% max in my 403, as I'm only allowed to use district-approved funds and vendors, all of which stink. We could max the 401 for this year, along with maxing roths for both of us. The remainder could go in a taxable account.

How does this sound?

Lkxe

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #13 on: March 02, 2015, 09:52:53 PM »
100k lump sum invested for 5yrs with a 7% return=140,255.17

20k/yr invested yearly for 5yrs with a 7% return=123,065.81

Third DCA option: 100k lump sum invested for 5yrs with ~10k added each year as budget allows, 7% return=187,762.56

Please correct me if I'm wrong, but doesn't the third option generate a better return? I understand that we're dealing with the 5% mortgage, but I'd rather have that safety net than blow the majority of our savings to eliminate the mortgage. Also, what difference would refinancing fees be versus the interest saved by simply paying off our current loan in 7 yrs?

Ah, yes the math, with historical averages that are not guaranteed.  The 5% interest is guaranteed, if you pay off the house and you aren't going to move anytime soon. The lack of house payment lowers the amount needed in case of emergency freeing more money monthly to invest. The real numbers are exactly that, the potential numbers not so much.

Faraday

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Re: CASE STUDY:Invest? Pay off mortgage?
« Reply #14 on: March 02, 2015, 10:05:42 PM »

Ah, yes the math, with historical averages that are not guaranteed.  The 5% interest is guaranteed, if you pay off the house and you aren't going to move anytime soon. The lack of house payment lowers the amount needed in case of emergency freeing more money monthly to invest. The real numbers are exactly that, the potential numbers not so much.

I agree with Lkxe: interest you'll pay on the house is GUARANTEED...that's way different than interest yields on investment. No matter what happens, you gotta pay the mortgage, you gotta have a roof over your house. And there's no better investment than the home you are living in when it comes to getting the money back out, especially if you carry insurance should the house be damaged or destroyed.

HOWEVER: whether you pay off the house or not, two things:

1) GOT to get rid of PMI, that's money lost that's not coming back. I'm liking the refi idea for that, but you are on the hairy edge of that one.
2) If you aren't putting the max in your 401k, you're giving money to the government that otherwise could be going to the 401k/pension plans.

I'm in a similar situation to you except I don't have the giant savings account. I'm paying off my mortgage as fast as I can on top of saving the max in 401k.  If I could pay off my house today (hence dropping my living expenses dramatically), I would. Then I'd work on optimizing everything else.

Lordy...if I could have paid off my house at your age, I've have been FI for 10 years by now....