Author Topic: Emergency fund versus paying down mortgage principle  (Read 2945 times)

mustacheMentee

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Emergency fund versus paying down mortgage principle
« on: October 11, 2015, 08:56:07 PM »
Hi fellow mustachians,

I'm new to the community, and trying to get my financial house in order. I've begun slashing my spending, and hopefully bringing my family along on the journey. I have a question about allocation of a chunk of money.

I have a mortgage of $396K @3.875%. I didn't have 20% down at the time, and so I'm paying $250 per month in mortgage insurance. I need to reduce my principle by another $36K to get the insurance removed. I currently have $25K in emergency funds and was wondering if I should consider saving the additional $11K and paying the principle down to remove the insurance. I could probably make this happen in under a year if I continue saving aggressively.

We have two other loans: 10K remaining in a car loan (boo) @ 2.5%, but this only costs $20 per month in interest, much less than the PMI for the mortgage. My wife has a student loan of $150K from vet school @3.75%, which we're going to have to continue to chip away.

I'm contributing 7% to my 401K (employer only matches to 4%).

So, given our total debt obligations above, any thoughts on using the $25K to pay towards the mortgage vs. keep it liquid and investing it?

Thanks!
óDarcy


andyp2010

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Re: Emergency fund versus paying down mortgage principle
« Reply #1 on: October 11, 2015, 09:17:05 PM »
Slightly left field here but what do you think the chances of your house being worth more than when you bought it are?

EG:

House bought $300k
Equity         $30k

10% LVR

New house value $340k
Equity $70k

20.6% LVR - No insurance condition and you get your liquid cash, all for the small price of a valuation.

Dicey

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Re: Emergency fund versus paying down mortgage principle
« Reply #2 on: October 11, 2015, 09:47:13 PM »
Would you have bought this house for 4.95% with no MI? I'm betting you would have. My rough calculation is that the payment on a loan of $396k at 3.875% + $250 PMI is approximately the same as $396 at 4.95% without MI, so it's not really as big a thing as it seems. Five percent is still a helluva good mortgage rate, historically.

The thing with mortgages and MI and EF's is that your house will rise in value over time, making your needed LTV's happen automatically. You have a great mortgage rate, so I wouldn't be in a huge hurry to pay it down at the expense of your EF. I'm assuming you are young. If so, the sooner you fill your retirement vehicles, the fewer actual dollars you will have to save for retirement. My advice is to crank the 401k to 10%, and fill up your EF to whatever level lets you sleep at night. After that, once you spend some time here and learn how to trim all the fat from your budget, divide what you can now save between taxable accounts (crucial if you want to retire early) and your wife's SL debt. By the time you have done that, your home probably will have risen in value enough on its own to kill the MI.

MDM

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Re: Emergency fund versus paying down mortgage principle
« Reply #3 on: October 11, 2015, 10:55:09 PM »
Would you have bought this house for 4.95% with no MI? I'm betting you would have. My rough calculation is that the payment on a loan of $396k at 3.875% + $250 PMI is approximately the same as $396 at 4.95% without MI, so it's not really as big a thing as it seems. Five percent is still a helluva good mortgage rate, historically.

The thing with mortgages and MI and EF's is that your house will rise in value over time, making your needed LTV's happen automatically. You have a great mortgage rate, so I wouldn't be in a huge hurry to pay it down at the expense of your EF. I'm assuming you are young. If so, the sooner you fill your retirement vehicles, the fewer actual dollars you will have to save for retirement. My advice is to crank the 401k to 10%, and fill up your EF to whatever level lets you sleep at night. After that, once you spend some time here and learn how to trim all the fat from your budget, divide what you can now save between taxable accounts (crucial if you want to retire early) and your wife's SL debt. By the time you have done that, your home probably will have risen in value enough on its own to kill the MI.
^Good advice.

mustacheMentee, welcome to the forum.  If you want more specific suggestions, consider http://forum.mrmoneymustache.com/ask-a-mustachian/how-to-write-a-'case-study'-topic/.

Retired To Win

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Re: Emergency fund versus paying down mortgage principle
« Reply #4 on: October 12, 2015, 10:31:02 AM »
... I'm paying $250 per month in mortgage insurance. I need to reduce my principal by another $36K to get the insurance removed. I currently have $25K in emergency funds and was wondering if I should consider saving the additional $11K and paying the principal down to remove the insurance... any thoughts on using the $25K to pay towards the mortgage vs. keep it liquid and investing it?

My answer is DO NEITHER.  Here is what I mean.

Emergency reserves need to be kept liquid.  So, no, I would not invest those reserves; I would keep them in a liquid savings account.

Emergency reserves are there to cover financial emergencies.  What happens if you take all your emergency reserve cash and throw it at your mortgage and then you get hit with an emergency (which, by definition, cannot be foreseen)?  Not a good position to put yourself in.

So, IMHO, in your shoes I would (1) calculate how much of an emergency reserve I really needed (6 months of living expenses?), (2) I would set that money aside in a dedicated savings account, and (3) then I would start saving money separately to whack down that mortgage principal bad boy.

Good luck.

Setters-r-Better

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Re: Emergency fund versus paying down mortgage principle
« Reply #5 on: October 12, 2015, 05:27:06 PM »
It would seem you need an emergency fund larger than 25K with such large debts? In any case, using the whole thing to pay down the mortgage principal would be extremely risky.

Bellatrix

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Re: Emergency fund versus paying down mortgage principle
« Reply #6 on: October 12, 2015, 07:23:39 PM »
I would love to throw my EF at my mortgage.  However, I think it is important to have cash easily accessible in case of a real emergency.  What if you lose your job and can't find another one for a few months?  What if your HVAC breaks and you need a new one?  Pretend your EF doesn't exist and figure out a different way to pay down your principle/get rid of your PMI. 

andyp2010

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Re: Emergency fund versus paying down mortgage principle
« Reply #7 on: October 12, 2015, 10:32:31 PM »
Firstly, I'm not sure why nobody else is suggesting getting your home revalued but thats ok.

Secondly, just thought. Assuming your house isn't worth more, why not have a revolving credit facility as part of your mortgage? Not as extra, split $25k off your current mortgage. This way your $25k is lowering your monthly mortgage payments and you've still got full access to it. Shouldn't really cost you anything if you don't spend it.


mustacheMentee

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Re: Emergency fund versus paying down mortgage principle
« Reply #8 on: October 14, 2015, 09:46:09 PM »
Thanks for the responses everyone. Many good points to consider. I appreciate the time.