Author Topic: Low interest debt - payoff or invest  (Read 2202 times)

thephantomqueen

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Low interest debt - payoff or invest
« on: April 16, 2014, 10:55:56 AM »
I'm not very good with financial literacy, I often don't understand the jargon that people toss about, but I'd appreciate plain English advice.

I am 35, I have a home mortgage with a 30 year fixed mortgage at 4.75% interest. I also have student loan debt but work in qualified clinical research and may be awarded a competitive grant from the NIH to pay off the student loan. {additional edit, I applied for this before and was extremely close to getting funded. I've spent the last year building my career portfolio that the program officer suggested so I have a very high chance of getting this in the next re-compete.}

Currently I am making minimum payments on both.

Now that I have a good cash and investment safety net, is it better for me to aggressively pay off the mortgage or increase my contributions to retirement accounts? Or should I do a combination (like maximize a Roth then dump all the extra into the mortgage?)

My current situation, I have the following:
Debt:
I have $53,600 in student loans (~4.5% interest fixed)
I have 83,350 in a 30-yr fixed mortgage (4.75% with wells fargo)
0 credit card debt

Income:
$4600 a month post taxes.


Savings/Investments:
I have about $15,000 in cash savings
Vanguard - current value $25,322
Work automatically puts 8% of my salary in the vanguard account with no matching or anything from me.
Two brokerage accounts (started years ago before I went back to school). Current total $16,250. I don't really touch these.

Feedback is greatly appreciated. Thanks.
« Last Edit: April 16, 2014, 12:18:55 PM by thephantomqueen »

Sonorous Epithet

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Re: Low interest debt - payoff or invest
« Reply #1 on: April 16, 2014, 11:51:25 AM »
This is a classic dilemma for those who suddenly have cash to work with, and a good problem to have. Both strategies will increase your 'stache and get you closer to FIRE, and neither is wrong. You should choose what feels right to you.

If you pay off the mortgage, you will have less cash flow in the short term until you pay it off, when you will suddenly have a metric buttload of cash flow. You'd need enough cash reserves to get you through emergencies, and in a real pinch you'd probably be looking at a HELOC or similar borrowing. If it's a big goal of yours to be debt-free, paying down your debt is a huge deal. If you have less than 20% equity right now, paying down the mortgage until you have 20% equity gives you the added benefits of eliminating PMI and giving you protection against becoming underwater if housing prices sink, letting you sell without having to pay the difference if you wanted. There's a good chance that the mortgage interest deduction won't be a factor for you, since an 83k mortgage is small, and you will probably still be using the standard deduction, or very close to it.

If you increase investments to retirement, you will likely build your 'stache a little faster on average, as you can expect to grow the money you put towards this at an average-over-time but volatile-in-the-near-term 7-8%, rather than the guaranteed effective 4.75% stache growth from paying the mortgage. If you have a high risk tolerance, this is mathematically smarter. If the idea of seeing your retirement accounts drop 40% in a year makes you want to sell sell sell, you may want to stick with the mortgage. If you need to access this cash, a Roth IRA is good (without taking the tax considerations into play), as you can access the contributions tax-free.

If it was me, I would see how much extra I could put towards the mortgage, plug it into a mortgage calculator, and see how long it would take to pay off. If I could get there quickly, I'd probably do that. So let's say you can put an extra $1,200 towards your mortgage. You could pay off your 30 year, $83,350 in less than 4 years. I'm pretty risk tolerant, but the idea of being free and clear on a house in 4 years sounds pretty amazing. If all I could spare was an extra $200/mo, it would be a 15 year payback period. Still nice, but that carrot is far away -- I'd probably invest then.

thesinecure

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Re: Low interest debt - payoff or invest
« Reply #2 on: April 16, 2014, 12:10:35 PM »
all depends on your goals, but if you want to be rid of some debt then i would develop a plan to get rid of the student loans unless you really think the grant is likely

i hate non-mortgage related debt, though, so that's part of my bias for picking the student loans as well

things i'd consider include:

1)  $15k savings seems pretty good, but this is kind of personal preference/comfort decision - it's roughly 4 months of your take home, is that a big enough cushion for you?  if so...

2)  i'd probably close the brokerage accounts and put that money toward the student loans - even if you did it a couple grand at a time if you weren't totally comfortable putting it all towards it at once, gets the ball rolling

3)  if your living expenses will allow it, you can probably develop say a 24 month plan to knock out the remaining @ $36k on the loans, and if the grant comes through you can then re-allocate to extra payments on the mortgage if that's what you want to do with it.  either way, any extra you have you put toward the loans.

4)  how long do you plan to own the house?  if more than two years, why not try and refi to a 15 year with a lower rate (i'm using 2 years as the approximate break-even point for refi's in terms of actual interest saved versus closing costs, but you'd need to run the numbers to figure it out exactly)

admittedly, the rate on the student loans is lower so from a pure economic standpoint the mortgage would likely have priority over that but ultimately there's nothing backing it which is why i'd probably pick it - your house is still an asset, even if its not liquid, the student loans are just a liability

if you itemize deductions on your tax return that could potentially change the economics (unless all interest from both is deductible), again something you'd need to do if you wanted to know exactly the benefits

good luck!  i know from experience that paying off loans is a great feeling, hopefully you've got that in your not to distant future!