Author Topic: Delete PMI, Pay down Student Loans or max 401k  (Read 6952 times)

nawhite

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Delete PMI, Pay down Student Loans or max 401k
« on: May 28, 2013, 12:08:02 PM »
Long story short, I'm starting a new job and buying a house and will have about $4000 a month extra after spending and mortgage to put towards the following things in any combination:

1. 401k (no employer matching, currently 28% marginal rate, at retirement I expect my tax rate to be around 15%)
2. Bringing the equity in my house up to 22% so I no longer need to pay PMI of about $100/month (would cost about $25k to get there from where I am now) (mortgage is at 3.75% so basically break even with mortgage vs investing)
3. Paying off $12k in student loan debt at 6.8% followed by $7k at 5% (followed by wife's 80k at ~3% but that may just stick around a while)

Am I correct in thinking that the return on money in the 401k is 13% and that the PMI return is 4.8% (100*12 /25000)? For the PMI do I need to include my mortgage interest in that calculation so that for that the return on that 25k is really 4.8 + 3.75 for a total return of 8.55%? The 8.5% kinda makes sense to me since that money not only is charging me the interest on the mortgage but the PMI payment as well.

I know I basically don't have a bad option out of these 3 and that this is really only an issue for a year or 2, but I want to maximize as much as possible. Right now I think the right answer is max out the 401k (~$1450/month) then the rest goes to getting to 22% equity and then goes to paying down the student loans.

Am I missing anything in my calculations?

pom

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #1 on: May 29, 2013, 09:50:08 AM »
I don't know your full situation but a few comments:

1a. If you put the max in your 401k, I suspect that you will end up at a tax rate higher than 15%. That will be a great "problem" to have.
1b. How did you calculate 13%: 0.28%-0.15%? If you did that, this is only a one-shot return. It is difficult to then compare it to annual interest savings.
2. Does the $100/ month include death coverage? If yes then it is only partly wasted money.

Still, even with my question unanswered, I suspect that your conclusion is right and that the best order is to contribute to 1 then to 2 then to 3.


nawhite

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #2 on: May 30, 2013, 08:37:05 AM »
Thanks for the reply pom.

1a. I guess it depends on how long I pay into it and how creative I get with pulling money out. I was planning on pulling money out of it as I went either with section 72 payments or a Roth ladder or both but I'll have to check my math.
For 1b, yeah that was how I came up with 13%, but you're right, I wasn't comparing apples to oranges. I still think it is the best place to put money first but the return wont be anywhere near 13%/year.

As for the PMI, I hadn't thought of death coverage, I'll have to look that up. Still mostly wasted money though haha.

Mostly thanks for checking my math!

Another Reader

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #3 on: May 30, 2013, 09:23:20 AM »
The return on paying off that 6.8 percent student loan is good, and I would focus on that and maxing out the 401k.  The PMI is annoying, but the student loans have the potential to harm you in the long run.  I would probably knock out the 5 percent one as well.  Even with maxing out the 401k, you will be left with enough money to dispose of these quickly.

Have you verified with your lender that you can remove PMI by paying the loan down by $25k?  I would not do this until I had the PMI removal rules for your loan in writing.

SwordGuy

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #4 on: May 30, 2013, 10:14:10 AM »
You have 7 months (plus maybe an additional paycheck) until the end of the year.
You're young, so the max 401k is around $17,000.  (Best to double-check the exact amount as it changes every so often).

With $4,000 per month to invest, you need 4 months pay plus $1,000 to maximize the 401k.  You have until the end of the year to do so. 

If you go the 401k route, consider filling it up at $4000 a month starting in mid-August.   That gives you Jun, July, 1/2 August and maybe the end-of-May paycheck to use for paying down the 6.8% student loan.  You would pretty much finish if off by then.

That would give you the student loan payment per month to do additional debt payment or investing with from then on, also.

HR will freak, of course.  Just remember to re-set it to a lower amount in time for your first January paycheck.  (Although I've seen posting from folks who max the 401k at the first of the year to maximize the time the money is growing in the non-taxable 401k environment.

Personally, it's been my experience that great, hard-working folks can still get laid off when the folks running the company screw up badly enough, and that there's often no warning that things are amiss.  Management tries to hide that info from folks.  That's why I like to minimize my debt - particularly the kind of debt like student loans that can't be discharged via bankruptcy.


aj_yooper

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #5 on: May 30, 2013, 02:19:29 PM »
There are definite advantages in maxing out your 401k, but I would look carefully at the mortgage amortization documents to see if paying ahead on your loan may be more to your advantage.  On a $200,000 loan at 3.75%, the first 7 months of payments include total principal payments of about $2100 and total interest paid of $4300; so a prepayment of 2100 saves 4300 in interest on the life of the loan, as you will be skipping ahead on the amortization schedule.  If you did $4,000 per month for 7 months, which would be a shock to your banker, you would be close to 15% equity, assuming you did a 3% down.  A little more and you would be at 22% and no more $100 per month PMI.  Remember, a prepayment means you pay the regular mortgage amount plus you send the extra money each month or in a lump sum; make sure your bank allows the prepayments.  Check and see if this would work for you. 

nawhite

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #6 on: May 31, 2013, 12:55:09 PM »
AJ, you are right about it saving me 4300 in interest over the life of the loan, but I have to think about what else I have to do with that money. Over the course of 30 years, at just 4% after inflation that 2100 in extra payment is worth $6800. So paying off the mortgage is worth ~6400 (2100 principle + 4300 saved interest) while investing the money is worth ~6800. 

So saying it will save me 4300 in interest over the life of the loan is one way of saying it, but investing it (even without the 401k) is a better move in this case if I can get a 4% return. So I still think I'm better off putting the max into the 401k (more for the additional tax savings and tax free earnings than anything else as a 3.75% garaunteed return sounds like a better bet than a likely 4% average over 30 years)

FlorenceMcGillicutty

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #7 on: May 31, 2013, 01:02:12 PM »
We had PMI for a while and I loathed it. It's just money out the door and it's not deductible. We got lucky with a refinance and our home value increased enough for us to pay down the mortgage with an affordable lump sum.

Has your home value increased since you last had it appraised? If you pay for an appraisal and you find you're at 20% equity, they'll remove the PMI without having to pay down 22%. You might want to look into the details to see if there's some wiggle room for you. That might change the order of your priorities.

Matt F

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #8 on: May 31, 2013, 01:14:07 PM »
For the PMI, check the rules on your loan on how fast you are allowed to eliminate PMI.  Most 30 yr FHA loans for instance require you to pay PMI for 5 years even if you pay down to 78% or less of the value.  You definitely do not want to get stuck paying down that loan then not even get to knock off PMI. 

For calculating your rate of return on PMI, that is also tough since you actually get a tax deduction for your PMI and your mortgage interest, but you only really benefit from the part of the deduction that is more than your standard deduction would have been (a point a lot of people forget). 

The way I like to calculate my options is to do a year by year cash flow analysis up until the year you want the money for each option, and see which option ends up with you having the most money in your target year, it builds all the difficult mental stuff like future value and present value of money into the calcs and let's you see how it works year by year.  The calcs can get confusing, I will normally do a column of salary, a column of taxes, a column of other expenses, then distribute the remaining money based on the option I am using.  Just remember to adjust the tax column based on which option you pick.

Let me know if you want more info!   

CorpRaider

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #9 on: May 31, 2013, 01:46:44 PM »
Noob here.  Hi everyone.  I'm in a very similar scenario to OP and I figured the 401(k) max is probably the first move here because I'm in a ~33% state and federal combined marginal income tax bracket and the PMI is tax deductible (congress fixed that at the very last minute last year, in case you missed it) and so is the mortgage interest.  Also hopefully I can earn  I'm probably going to hit the student loan debt second at least the 6.25% amount, because the deduction on that phases out for the student loans.  I was hoping to refi and get rid of the PMI but my appraisal came back lower than I expected.  I plan to just wait six or so months and if mortgage rates are about where they are now (or if lenders get more liberal about going above 80% LTV, I will refinance and dump the PMI.  I figure it will only take a little over a year to cover a couple grand in closing costs with PMI at ~$157.  Hopefully, I can earn more than 6.25% in the 401(k) and then add on the tax deferral and the tax deduction for the interest on the loans.

SnackDog

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #10 on: May 31, 2013, 02:56:29 PM »
Top of your emergency fund first.  Otherwise, if the job has a surprise and you lose it you could be in deep doo doo.

nawhite

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #11 on: May 31, 2013, 09:18:16 PM »
CorpRaider, without kids and a relatively small mortgage, I'm not expecting the PMI + mortgage interest to be much bigger than my standard deduction so I'm ignoring the PMI being tax deductible. As for the student loans, I'm still going to have to make minimum payments on which the interest is going to be more than $2500 for the year so I don't get to deduct all of that interest either.

So all in all the tax implications of choosing PMI vs Student Loan extra payments comes out effectively as a wash for me so I was ignoring it.

Thanks for all the feedback everyone. Its all very helpful. Especially the reminder to top off the emergency fund!

CorpRaider

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #12 on: June 02, 2013, 03:23:47 PM »
Interesting.  Its not more than the standard deduction even when you throw in your state and local taxes?  I might be getting ripped off on my S&L because my mortgage is only $164,000 @ 4%.

nawhite

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #13 on: June 02, 2013, 10:35:45 PM »
CorpRaider, I'm confused how state and local taxes play a part? I guess I'll run the math on this mortgage interest deduction b/c I never actually ran it before.

With about a 200k mortgage the monthly payment is ~$1000/month and even if 100% of it was just paying interest then my total mortgage interest for the year would be $12000/year. So then lets add on PMI at $100/month, I'm spending ~$13200/year in interest and PMI. The standard deduction for married filling jointly last year was $11,900.  So in this case the mortgage interest deduction only reduces my income by an additional $1100. Lets assume a 35% marginal tax rate (making up numbers for state and local, idk what they are off the top of my head), then having a mortgage interest deduction saves me <$400/year vs just using the standard deduction. And that is only in year 1 and assuming that 100% of my payment goes to interest. Where else do state and local taxes come into play?

So I guess that I would be able to deduct the PMI which does provide some savings, just not much. And it would only be helpful for a couple years while I'm paying mostly interest on the loan.

Matt F

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #14 on: June 03, 2013, 07:31:20 AM »
State and local tax are deductible on your Fed Return if you itemize deductions.  They are not enough money generally for people to itemize unless they have a mortgage, then the combination of mortgage interest, PMI and state and local taxes can all add up to be pretty significant.

nawhite

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Re: Delete PMI, Pay down Student Loans or max 401k
« Reply #15 on: June 03, 2013, 12:32:13 PM »
Well, that shows my ignorance about what is deductible. I love this forum. *Goes to find state taxes from this year and re-run the math.*