Author Topic: Done with Loans (mostly) where to put the $$?  (Read 2195 times)

frugal_engineer

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Done with Loans (mostly) where to put the $$?
« on: June 10, 2014, 06:23:31 AM »
Next month I'll have completed paying off my student loans that have an interest rate > 5%.  I'll still have ~$5k left at 5.0% (perkins), but that is at a fixed monthly payment of $65 for the rest of time.  Furthermore, based on the amortization rate for the loan, I'll end up paying < $2k in interest of the life of the loan.

I'm pretty sure I can do better with that $2k elsewhere, so I'm planning to leave the $65/mo ongoing until its done and ignore it.  That leaves me with the question of where to put the $1k/mo that was going to the rest of the loans.

Goals:
1. Build stash
2. Get enough cash for a good size down payment on a house - unfortunately in our area thats in the ~$100k range min to hit 20%.

Options for what to do with the $ that used to go to loans:
1. Taxable investment account (Roth is maxed, no 401k from my company, they give a straight 7.5% salary match into an SEP-IRA that I cant contribute to)
2. Lending Club
3. Savings account

Thoughts:
I hate putting any money into the stupid savings account (~$5k in there now) because of the god-awful 1% interest. But, the time horizon on the down payment is likely 2-3 years so that would have the best liquidity.

Lending club seems like its only good for long term stashing, its not very liquid.

I might end up even worse off taking down payment funds out of the taxable account than had I left it in the savings account after taxes and how the stock market is feeling that year.

That being said, I'm leaning towards something along the lines of $500 in taxable or LC and $500 in the savings each month.

What does the MMM forum recommend?

Bonus Question:
If I pull out contributions from the Roth to fund a down payment, do I get to put those contributions back in later?  I.e. if I pull out $25k of contributions do I get to put in the $5.5k (or whatever the limit is that year) + the $25k in the next year? Or is that contribution ability lost once the contributions are pulled?

rmendpara

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Re: Done with Loans (mostly) where to put the $$?
« Reply #1 on: June 10, 2014, 07:33:33 AM »
Next month I'll have completed paying off my student loans that have an interest rate > 5%.  I'll still have ~$5k left at 5.0% (perkins), but that is at a fixed monthly payment of $65 for the rest of time.  Furthermore, based on the amortization rate for the loan, I'll end up paying < $2k in interest of the life of the loan.

I'm pretty sure I can do better with that $2k elsewhere, so I'm planning to leave the $65/mo ongoing until its done and ignore it.  That leaves me with the question of where to put the $1k/mo that was going to the rest of the loans.

Goals:
1. Build stash
2. Get enough cash for a good size down payment on a house - unfortunately in our area thats in the ~$100k range min to hit 20%.

Options for what to do with the $ that used to go to loans:
1. Taxable investment account (Roth is maxed, no 401k from my company, they give a straight 7.5% salary match into an SEP-IRA that I cant contribute to)
2. Lending Club
3. Savings account

Thoughts:
I hate putting any money into the stupid savings account (~$5k in there now) because of the god-awful 1% interest. But, the time horizon on the down payment is likely 2-3 years so that would have the best liquidity.

Lending club seems like its only good for long term stashing, its not very liquid.

I might end up even worse off taking down payment funds out of the taxable account than had I left it in the savings account after taxes and how the stock market is feeling that year.

That being said, I'm leaning towards something along the lines of $500 in taxable or LC and $500 in the savings each month.

What does the MMM forum recommend?

Bonus Question:
If I pull out contributions from the Roth to fund a down payment, do I get to put those contributions back in later?  I.e. if I pull out $25k of contributions do I get to put in the $5.5k (or whatever the limit is that year) + the $25k in the next year? Or is that contribution ability lost once the contributions are pulled?

I'd say this about the $5k remaining. You mentioned it's only $2k in interest over the life of the loan. I'll trust your numbers for a minute. Regardless, this is only "actual cost" as it's referred to in economics. The "opportunity cost" is an additional cost on your money because of what you could be earning by investing it elsewhere.

Example: Let's say you pay off the $5k this year. Over the following 12 months, you will have $65 x 12 = $780 in additional cash flows you didn't have before. Let's also assume this has 10 years remaining.

http://www.calculatorsoup.com/calculators/financial/future-value-annuity-calculator.php

Now we will calculate the future value of an ordinary annuity (for simplicity, assume one payment at the end of each year of $780 into some investment earning 5%, compounded annually, for 10 years). That's a gross investment of $5,000 over 10 years, however, at the end of 10 years, your payments, at a very conservative return of 5% annually, will be worth $9,810. (t=10, R=5%, m=1, pmt=780, g=0, q=1)

So, do you still think this loan is only costing you <$2k in interest over the life of the loan? Think again. We can make the numbers say anything we want them to tell us. It's all about perspective.

Anyway, that's another point besides what you posited in your post.

Since you want to do 2 things, namely: 1) Invest, 2) Save for house dp.

The "safest" way to do this is to slowly build up your liquid savings. It would stink to invest your dp for a few years only to have the market go sour, and your contributions are worth less than you put in. A better strategy, not risk free, would be to split your dp savings between cash and some sort of investments. This way, if the market goes down a little, you won't have to take a huge loss, but can also make an opportunistic purchase if a good deal on a house comes along.

As far as the investment, it could be in a taxable account or a Roth. I'll address Roth first. In a Roth account, you can withdraw up to the total of your contributions without penalty. The problem here is obvious, you are no longer earning anything once you withdraw and will only start earning again once you re-deposit your earnings. In a taxable account, you have a similar risk that once you cash out investments, you could either be in a gain/loss position. Gain would be better, obviously, but you'll have a small tax hit. Loss would not be ideal, but you will be able to carry forward losses to offset future gains... so not a complete loss. Do not withdraw from Roth if it's in a loss position, because you will effectively have to repay the loss since you can't deduct it anywhere.

I would summarize as this: Withdraw from a Roth if you are in a gain position in both Roth & taxable account (so you don't have to pay the tax at that time). Withdraw from the taxable account if you are in a loss position in both since you do not get to deduct losses for a Roth.

I have never withdrawn from investments/Roth before, so I'm sure someone else can probably fill you in on some other details I may have overlooked. But, my understanding is that you have to re-deposit anything you withdraw.

In any case, your best bet is to do a bit of both. Decide on a split that you feel comfortable with (e.g. 20% Roth and 80% taxable... or contingent on gain/loss position... or whatever you decide helps you sleep at night).
« Last Edit: June 10, 2014, 07:38:36 AM by rmendpara »

frugal_engineer

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Re: Done with Loans (mostly) where to put the $$?
« Reply #2 on: June 10, 2014, 08:15:04 AM »
Agree with taking into account the opportunity cost. However, the opportunity cost of the $5k lump today is $3234 @5% return ($8243 total value) so the opportunity cost of paying it all now is only another $1566 ($9810-8243) assuming I only get 5% return. Since that's on the low side, I think not paying the chunk now still puts me ahead.

waltworks

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Re: Done with Loans (mostly) where to put the $$?
« Reply #3 on: June 10, 2014, 08:36:45 AM »
If a DP for a house is your #1 goal, you are probably best off just sucking it up and (sigh) putting all your money in the savings account. You basically have zero risk tolerance in this scenario.

If the house goal is not set in stone (ie you'd be ok renting for a decade if needed) then throw caution to the wind and start buying S&P index funds or something. Over a longer time frame that's probably a smarter move but only you know how to prioritize your goals.

-W

Prairie Stash

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Re: Done with Loans (mostly) where to put the $$?
« Reply #4 on: June 10, 2014, 11:33:03 AM »
Since it's only $5K I'd pay off the loan with the savings account.  Rough math says you'll save 4%/year on 5k for 3 years so $600.  KISS principle, no need to get fancy with small money. There's lots of reasons for and against and thousands of scenarios, mainly I like simplicity and nothing is simpler than figuring out math on loans of $0.

Next maybe some bonds? Dabble with the safer investments for a house 3 years out.  At the least you'll be an expert on bonds by the time your house is saved for, it's great education.