After refinance, what should I do: Pay off loan, pay off mortgage, or invest?

[motipha]

Oh man, I'm having trouble figuring out what to do with this.

So I recently refinanced, and in the aftermath find myself in a complex situation.  Turns out that I was under water and as part of my refinance I ended up having to pay off the difference between what I still owed and the appraised value.  Factoring in closing costs, this amounted to about $17k in closing costs.

Previous situation:  I was debt free barring my mortgage before the refinance, but with all my investments in a 401k.  This was my model prior to my introduction to mustachianism, and the idea of early retirement.  The Mortgage was a 30 year fixed at 5.45% with 28 years left.

Current situation:  My mortgage has been changed to a 10 year interest only ARM with an initial rate of 3.5%, no PMI.  I have a $17k 10-year loan at 3% (my father provided, the only way the refinance became possible).  I have a vanguard Index fund that I am using as my primary early retirement vehicle, while still maxing out my 401k (the debate about 401k versus IRA is another thing entirely).

I'm currently paying in the following fashion:
1) paying towards my mortgage on a schedule to be completed in 12 years (starting at $680 in principal a month)
2) paying off the loan at a rate to pay it off in 3 years. (~ $500 in principal a month over lifetime)
3) paying towards investment at least 300 a month, with any unspent earnings adding to that amount.

Right now, I feel this is a good middle ground:  I am guaranteeing myself best use of the ARM, and since I'm intent on not having a mortgage sooner than the 30 years alloted the ARM made sense to me.  I'm getting rid of an unwanted debt, given the mustachian stance that any debt beyond your mortgage constitues an emergency and takes precedence.  At the same time, I'm building some passive income to support my early retirement goals (I'm hoping to retire somewhere within 7-10 years).

But I'm not convinced this middle road is the best way to go, so I'm asking advice specific to the loan.  Yes, it's a loan, and therefore bad bad BAD, but to pay it off any quicker I'd have to delay putting money in to investments (and slowing my build of non-age related passive income) and pay only the minimum on my mortgage (adding to the risk associated with the ARM, given that my minimum is just interest).  Alternatively, I could only pay the minimum on this loan for it's lifetime, and push the extra towards my investments to build passive income, given that the interest rate is way lower than expected rate of return from an index fund.  But what makes the most amount of sense?

[warped]

You have to figure out what's important to you, because different values would lead to different results.

For example, if you have no family/safety net, the liquidity factor becomes important, and keeping a nice size emergency fund can lead to minimum payments.

However, personally, if there's one thing I *hate* worse than credit card debt, it's debt to family.

Personally, I'd make minimums on everything other than that, and just get that gone.

I'd skip maxing out the 401k ($17,000/year is the whole loan!) and get that down to only what the employer will match.

That would free up a lot to add towards the family loan, it'll only be a short time then you can jack it back up.

ARM's make me nervous, I'd probably focus on getting that paid down next, with the extra investments last.

Sort of a snowball type approach.

[CU Tiger]

I would pay the debt to family first, then increase investing in the 401k while hitting the mortgage with some extra every month. It doesn't have to be an either/or thing with the mortgage and investing, you can do them both at the same time.

Owing money to friends and family is just bad juju in my mind. Even if they never say anything, if you spend money on things they think are foolish while owing them cash, it can affect your relationship. Pay off your Dad, and thank him sincerely for the help!

[Catbert]

I got to agree with the others: pay your dad off first.  It's nice that you can have family as your "emergency fund."  The best way to  ensure that they are willing to lend you money in the future is that you pay it off ahead of time.   

And yes, I would do it even if my dad said he didn't care if e got paid back early. 

[clutchy]

I guess I don't understand why you'd do a 10 yr. ARM when you can get a 3.25-3.5% 30 yr. fixed. 

It allows for flexibility without any of the interest rate risk you're now looking at.


Just to give you some idea what I did... 4.875% refi'd to 30 yr. fixed @ 3.25%.  I was paying my mortgage off early, but now I can go out on the open market and buy equities and securities that easily yield the rate of my mortgage.  My mortgage will be paid off by the income from the equity instruments.  I get to keep both the house and the securities at the end. 

I'm not convinced your way takes into account the risks presented by the financing arrangement you've chosen.  I do hope it works out for you though.

[foobar]

He did an interest only mortgage. That drops the payments during the first 10 years by a good chunk in exchange for much higher payments in year 11-30. The plan is pretty much to refinance before you hit that point.

You always have to remember the cost of avoiding the interest rate risk. You are paying  ~.5% more (than an 10 year arm) for that. Depending on your life it may make sense.

Personally I would pay my dad back, dump the rest into vanguard, and in 10 years hope that the market has returned 7%+ so that you can take advantage of the interest arbitrage. These 3% mortgages are really cheap money. When mortgages go back up to 6%+ then it will be much harder to beat the returns of just paying off the mortgage.

I guess I don't understand why you'd do a 10 yr. ARM when you can get a 3.25-3.5% 30 yr. fixed. 

It allows for flexibility without any of the interest rate risk you're now looking at.


Just to give you some idea what I did... 4.875% refi'd to 30 yr. fixed @ 3.25%.  I was paying my mortgage off early, but now I can go out on the open market and buy equities and securities that easily yield the rate of my mortgage.  My mortgage will be paid off by the income from the equity instruments.  I get to keep both the house and the securities at the end. 

I'm not convinced your way takes into account the risks presented by the financing arrangement you've chosen.  I do hope it works out for you though.

[clutchy]

^ interest only was the component I was missing. 

but if you're paying principal anyways?  I guess it just exceeds my risk tolerance.

[motipha]

Thanks for the responses everyone!  It sounds like most people are on the same page I was on, initially:  Loans from family are bad juju, no matter what the relative rate.

However, I'm going to through a twist on it:  The loan is not actually from my dad, but from the family trust.  Instead of dealing with probate and all that nonsense, my family has set up a trust fund that is intended to hold assets that are to be passed down through the family.  It's currently funded from the estate of my grandparents, and is not part of my parents planning save as a last measure or occasional high cost luxury items.  My dad originally convinced me to take this loan because he wanted to put that money to work, and helping out his kid seemed like a good way to put it to work.  The amount of the loan, while non-trivial, does not make up a huge percentage of the value of the fund.

Given this information, how do people feel about the loan?  is it still too much of "loaning money from the family" to be stomached?  if it does remove the ethical dilemma, how does that affect peoples math about Loan vs mortgage vs investment?

regarding the mortgage... basically, it was the flexibility of the interest only.  Being able to drop my payments down to just interest for a few months when I needed some extra money was a good selling point, especially because I was planning on paying off the mortgage as quickly as I could stomach.  The only complication on that is my need to have passive income at the point of retirement, which would be about when the loan would be paid off (7-10 years).  If I'm going to be making enough to cover my expenses by that point, I'm going to have to be putting a lot away at the same time.  While Loan and mortgage payments can factor in to my savings rate, they don't help my passive income a jot.

[foobar]

It depends on the trust. Maybe they would rather loan you money at 3% instead of invest it at 10% since the purpose of the trust is to support you someday. And the other question with family loans is what do other people think. Is there a Sister/Uncle/... who is upset that you could borrow 20k for your house but they couldn't get the money for something they wanted?

Interest only is great if you can deal with the fact that in 10 years the monthly payments are going to double (you have to pay the principal off over 20 years versus 30). That shouldn't be a problem if you have been investing that money for 10 years. On the other hand if you are using the interest only in order to make ends meet, things can go bad.  The common thought is "well I will just refinance in 7 years") which sounds great. But you should assume the interest rate in 7 years will be 6 or 7% when you try and figure out if you can afford the loan going forward.

Thanks for the responses everyone!  It sounds like most people are on the same page I was on, initially:  Loans from family are bad juju, no matter what the relative rate.

However, I'm going to through a twist on it:  The loan is not actually from my dad, but from the family trust.  Instead of dealing with probate and all that nonsense, my family has set up a trust fund that is intended to hold assets that are to be passed down through the family.  It's currently funded from the estate of my grandparents, and is not part of my parents planning save as a last measure or occasional high cost luxury items.  My dad originally convinced me to take this loan because he wanted to put that money to work, and helping out his kid seemed like a good way to put it to work.  The amount of the loan, while non-trivial, does not make up a huge percentage of the value of the fund.

Given this information, how do people feel about the loan?  is it still too much of "loaning money from the family" to be stomached?  if it does remove the ethical dilemma, how does that affect peoples math about Loan vs mortgage vs investment?

regarding the mortgage... basically, it was the flexibility of the interest only.  Being able to drop my payments down to just interest for a few months when I needed some extra money was a good selling point, especially because I was planning on paying off the mortgage as quickly as I could stomach.  The only complication on that is my need to have passive income at the point of retirement, which would be about when the loan would be paid off (7-10 years).  If I'm going to be making enough to cover my expenses by that point, I'm going to have to be putting a lot away at the same time.  While Loan and mortgage payments can factor in to my savings rate, they don't help my passive income a jot.

[motipha]

Hi Foobar.  While the loan is interest only, I am paying enough principal to pay down on a 10-12 year track as it is.  The benefit of the interest only is that when I have a particular thing that I want/need a large sum of cash for, I can scale back to just the interest in order to accumulate that money faster.  In my mind, less mandatory expense per month means more flexibility to pick and choose where I make my savings.