Author Topic: Max 401k, or put towards paying off house?  (Read 1666 times)

nexus

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Max 401k, or put towards paying off house?
« on: February 04, 2021, 08:12:57 PM »
Hello you sexy mothertruckers!

DW and I bought a house at the end of 2020, and moved from CA to TN where we're no longer paying state income tax (I'm not, at least). This gives me an extra $500ish take home per pay period since I'm not paying CA state income tax. We can round that to $10k if it helps... I'm nearly 31 years old, and have been maxing my 401k for the last 2-3 years. I -think- our FI timeline is in the next 10 years*, max. Part of our FIRE plan involves having a paid off house (we owe $398k, put 20% down -- house is worth about $510k based on Zestimate. we paid $504k, if it matters.)

So I'm wondering... should I drop my 401k contributions down to the company-match level (6%, dollar for dollar match), or keep maxing it out? It is my "Old Me Money" and unless I do the conversion, pay the taxes on it, and wait 5 years after the conversion I won't be touching it until retirement age, which by that time will be a considerable sum IMO. My 401k balance is ~120k at the moment, and if it compounds at 7% over the next 30 years it will be well beyond what I think we need to sustain ourselves indefinitely.

As it stands, out mortgage is just under $2k/month with $370 going into escrow for taxes & insurance and the remaining being split almost-evenly between interest & principal. I am throwing an extra $1k per month into principal only payments.

I am thinking the money I don't put towards the 401k could go to paying off the house faster. Without the house payment our monthly spend is $1,500 at the VERY MOST, which is $18k annually. We'd need $450k stash to sustain that, of which I already have ~$210k in index funds. With my current setup, I'm adding $500-$1k to that account per month, depending on what's left**. I'll ideally get to  $500k in the taxable account and completely get out of corporate America and just rely on my side hustle.

DW will probably work in some capacity much longer than I will -- she likes her job

Has anyone else done this, or do you have any advice? As it stands I'm still scheduled to max my 401k for 2021, but am really open to dropping it down to just get the company match if you guys think the money could be better utilized elsewhere?

Last point, given my balances are large enough to where the gains are starting to match/beat the level of contributions, I am optimistic. If the balances and performance were poorer, I probably wouldn't even be considering it. I'm also open to the suggestion that I should hit $x amount in the 401k then just let compounding take over, but I feel like I'm pretty much there given the balance and timeline until I can access it as an Old Person.

Thanks, as always for the face punches and words of wisdom :)

* I'll still hustle part-time, working as a tennis instructor and racket stringer so my income will not be entirely $0, and have the option of scaling up/down as needed.
** our spending is a little higher than normal given the move (to a larger place) and one-off home projects.

jrhampt

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Re: Max 401k, or put towards paying off house?
« Reply #1 on: February 05, 2021, 07:57:42 AM »
I would always max out my 401k before putting extra money toward paying off the house.  Anything you can put into a 401k lowers your taxable income.

zolotiyeruki

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Re: Max 401k, or put towards paying off house?
« Reply #2 on: February 05, 2021, 09:07:30 AM »
Normally, I tell people to make sure they have enough money available in taxable accounts and Roth contributions to cover 5 years of living expenses while they build their Roth Pipeline, but you've already easily cleared that number.  This is just another iteration of the "pay off the mortgage vs invest" debate, which only happens a few hundred times per hear on the MMM forums...

Mathematically, you'd be better off not paying off the house early, and plowing that money into your 401k for the tax benefits.  On the other hand, paying off the house early is great for peace of mind.

Beach_Stache

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Re: Max 401k, or put towards paying off house?
« Reply #3 on: February 06, 2021, 06:06:25 AM »
Mathematically, you'd be better off not paying off the house early, and plowing that money into your 401k for the tax benefits.  On the other hand, paying off the house early is great for peace of mind.

+1, if you got a mortgage in 2020 then your interest rate is most likely very low.  I used to pay down the house at 3.75% and it put us in a good position, then we re-financed a year ago and it made no sense to pre-pay the mortgage, so we take what we were pre-paying and invested in post-tax (already have been maxing retirement accounts for years).  It took time to get my head around that and not paying down the house, as I did want that peace of mind, but financially it makes sense to keep the mortgage.

I play around with "Karl's Mortgage Calculator" a lot, and seeing what we were pre-paying and what it does to the mortgage and what it would be by investing helps a lot, it also helped a lot to maximize our payments when we were pre-paying our mortgage.

It's still hard to carry a mortgage balance but ultimately I know it's best to not pre-pay anymore b/c our rate is so low.

RWD

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Re: Max 401k, or put towards paying off house?
« Reply #4 on: February 06, 2021, 08:25:49 AM »
Absolutely max your tax advantaged space before paying extra on low interest debt

nexus

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Re: Max 401k, or put towards paying off house?
« Reply #5 on: February 08, 2021, 10:12:56 AM »
Thanks everyone -- it sounds like paying the house off early is the least efficient use of extra cash.

Sandi_k

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Re: Max 401k, or put towards paying off house?
« Reply #6 on: February 08, 2021, 10:57:01 AM »
Thanks everyone -- it sounds like paying the house off early is the least efficient use of extra cash.

Agreed, at sub-3% it doesn't make a lot of sense to pre-pay. And yet...having a paid off house is attractive at a comfort level.

The way we optimized for both sides of the mortgage camp: got a 15 year mortgage instead of 30 years.

It means we save tens of thousands in interest over the life of the loan. But it also means that right off the bat, we were paying so much in principal every month that pre-paying was a ludicrous exercise.

So now we happily stash cash in the market, knowing that we never have to think about what to do with the mortgage again. ;)

cool7hand

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Re: Max 401k, or put towards paying off house?
« Reply #7 on: February 09, 2021, 08:25:12 AM »
While I agree on the math favoring the 401k, there's nothing wrong with paying down the mortgage first if that is better psychologically. While I don't go for all the religion Dave Ramsey smuggles into his advice, I think he's right that some people just do better by first paying down all debt first. It just feels good to be debt free, and some people start building their own financial snowball faster this way. Whatever you decide to do, congratulations on rejecting conventional consumerism!!

nexus

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Re: Max 401k, or put towards paying off house?
« Reply #8 on: February 09, 2021, 11:08:42 AM »
Thanks everyone -- it sounds like paying the house off early is the least efficient use of extra cash.

Agreed, at sub-3% it doesn't make a lot of sense to pre-pay. And yet...having a paid off house is attractive at a comfort level.

The way we optimized for both sides of the mortgage camp: got a 15 year mortgage instead of 30 years.

It means we save tens of thousands in interest over the life of the loan. But it also means that right off the bat, we were paying so much in principal every month that pre-paying was a ludicrous exercise.

So now we happily stash cash in the market, knowing that we never have to think about what to do with the mortgage again. ;)

That's great, congrats on some pretty sweet optimization.

I had the option for the 15 year, but decided not to do it. I was a little worried about my wife's income and wanted the safety net of a smaller monthly payment -- with the idea that when her work ramps up we'd get much more aggressive with the payments. That being said, my income is more than enough to cover our monthly expenses 2-3x so her income is just icing on the cake.

Oddly enough, my lender wanted a higher interest rate for the 15 year versus the 30 year which was a turn off despite knowing slightly higher interest rate over a shorter time would still reduce the cost of the loan.

I think what I'll do (did some research and my lender gives me the option) is just autopay half my mortgage payment biweekly. This should shave off some interest owed over the lifetime of the loan and cut down the timeline to pay it off. I can still throw some extra money at the loan sporadically.

I'm a little wishy washy on the plan of attack -- part of me wants to get the balance down to a smaller number like $250k, then just do the monthly minimum payment. By that time, maybe 3 years from now, the investment and cash balances will have grown enough to dwarf the remaining balance owed, and owing 2.65% on $250k is nothing to lose sleep over. I can probably do this while still maxing the 401k.

[thinking out loud]
The psychology is tricky. Paying off the house means that's $2k* less per month we'd spend. It also means I could leave my job and take a much lower paying, or part-time, gig and still be able to make ends meet comfortably. There's really no other expense we can control / reduce that lowers our monthly outflow that significantly. Maybe this is more of a lean FIRE versus fat FIRE conundrum? Fat FIRE would require a larger stash to cover expenses including the mortgage. Lean FIRE would require a smaller stash and paid off house. That's where my brain gets muddy with the numbers -- can I get to Fat FIRE faster than lean FIRE by putting extra money towards investments instead of paying down the house? The benefit would be that after the house is paid, Fat FIRE really is fat. Maybe the difference in timelines is negligible.

* Actually it's $2k minus the property tax & insurance which is ~$350, so really closer to $1.6k

nexus

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Re: Max 401k, or put towards paying off house?
« Reply #9 on: February 09, 2021, 11:10:51 AM »
While I agree on the math favoring the 401k, there's nothing wrong with paying down the mortgage first if that is better psychologically. While I don't go for all the religion Dave Ramsey smuggles into his advice, I think he's right that some people just do better by first paying down all debt first. It just feels good to be debt free, and some people start building their own financial snowball faster this way. Whatever you decide to do, congratulations on rejecting conventional consumerism!!

Thanks!
+1 on the Dave Ramsay opinion
+1 on feeling goot .. goot? g-o-o-d. SMH -- feeling good to be debt free. :)

Proud Foot

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Re: Max 401k, or put towards paying off house?
« Reply #10 on: February 09, 2021, 01:45:53 PM »
I wouldn't cut down your 401k contributions to pay extra. You said your move freed up $10k estimated by not having state income tax. Why not keep maxing your 401k and use this amount to pay extra on the mortgage?

Sandi_k

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Re: Max 401k, or put towards paying off house?
« Reply #11 on: February 09, 2021, 02:17:00 PM »


I think what I'll do (did some research and my lender gives me the option) is just autopay half my mortgage payment biweekly. This should shave off some interest owed over the lifetime of the loan and cut down the timeline to pay it off. I can still throw some extra money at the loan sporadically.

Be careful with this plan: most mortgages clearly state that they WILL NOT APPLY your payment until the entire amount is received. So you pay half the mortgage, and it sits in a collection account until you pay the second half, and you do not advance the principal payment at all.

I'm a little wishy washy on the plan of attack -- part of me wants to get the balance down to a smaller number like $250k, then just do the monthly minimum payment. By that time, maybe 3 years from now, the investment and cash balances will have grown enough to dwarf the remaining balance owed, and owing 2.65% on $250k is nothing to lose sleep over. I can probably do this while still maxing the 401k.

If you want to be paying lump sums and buying down the principal, be aware that the minimum amount due does not change. Since your term is 30 years long, they will continue to charge the full amount of interest due now. You will ONLY see the reduction in time on the payments, not a reduction in amount due monthly.

[thinking out loud]
The psychology is tricky. Paying off the house means that's $2k* less per month we'd spend. It also means I could leave my job and take a much lower paying, or part-time, gig and still be able to make ends meet comfortably. There's really no other expense we can control / reduce that lowers our monthly outflow that significantly. ... can I get to Fat FIRE faster than lean FIRE by putting extra money towards investments instead of paying down the house? The benefit would be that after the house is paid, Fat FIRE really is fat. Maybe the difference in timelines is negligible.

* Actually it's $2k minus the property tax & insurance which is ~$350, so really closer to $1.6k

And this is why we did a 15 year mortgage. Just because your current lender had a weird structure where a 15 year had a higher interest rate, it doesn't mean that that is normal. They are clearly pushing people to the 30 year term because it is more profitable for THEM. And yes, the investments will typically turn out better than the minimum amount you save on your mortgage by pre-paying it.

If you're going to drive yourself nuts over this, I stand by my rec to get a 15 year term, from another lender, and then declare this question solved, and optimized enough. Freeing up brain space on this is a real benefit.

You can still throw a lump sum at it any time along the way to reduce the balance.

If you do not want to refi, here are the ways you can reduce interest paid overall:

1) Pay off a lump sum once a year or so. Ask the mortgage company to then RECAST your mortgage. So if you throw a lump sum of $10k towards principal, you can ask for a re-amortization of (current balance minus $10k), and then re-amortized over the 29 years remaining on the mortgage. There are two advantages: smaller balance reflects lower interest right away, AND your monthly payment is reduced. However, many companies charge a re-cast fee, to make up for the hypothetical future interest.

2) Instead of a bi-weekly payment plan that doesn't get credited, you can still pay monthly. But add 1/12th of your principal payment to each payment, credited against the principal. That does the same thing as a bi-weekly payment, but it ensures that it is credited right away - since you send it in with the FULL mortgage payment as required.

Honestly, if IIWY, I'd explore a 20 year term mortgage. It's the best of both worlds: not as spendy as a 15 year mortgage, but huge improvements in the ownership percentages, since such a large part of your payment goes directly to principal.

jeromedawg

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Re: Max 401k, or put towards paying off house?
« Reply #12 on: February 09, 2021, 06:44:55 PM »
@Sandi_k and others, do you recommend getting a 15yr mortgage from a smaller institution such as a smaller credit union? Or do you recommend going with a larger institution like a big bank?
I have no idea how to 'optimally' shop around for the best mortgages/rates without getting the fleece pulled over me. Right now I have pre-approvals for 30yr loans through Wells, Chase and then a broker that my realtor recommended.

Sandi_k

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Re: Max 401k, or put towards paying off house?
« Reply #13 on: February 10, 2021, 10:32:23 AM »
@Sandi_k and others, do you recommend getting a 15yr mortgage from a smaller institution such as a smaller credit union? Or do you recommend going with a larger institution like a big bank?
I have no idea how to 'optimally' shop around for the best mortgages/rates without getting the fleece pulled over me. Right now I have pre-approvals for 30yr loans through Wells, Chase and then a broker that my realtor recommended.

We got our last two mortgages from Penfed Credit Union (set up an account with $50 in it and you're done with membership requirements) and Quicken.

Penfed was better with rates, but I had to ride herd on them DAILY to get it done. I loved the Quicken experience - even if it was a little higher interest rate, they did it quickly and well.

jeromedawg

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Re: Max 401k, or put towards paying off house?
« Reply #14 on: February 10, 2021, 11:44:40 AM »
@Sandi_k and others, do you recommend getting a 15yr mortgage from a smaller institution such as a smaller credit union? Or do you recommend going with a larger institution like a big bank?
I have no idea how to 'optimally' shop around for the best mortgages/rates without getting the fleece pulled over me. Right now I have pre-approvals for 30yr loans through Wells, Chase and then a broker that my realtor recommended.

We got our last two mortgages from Penfed Credit Union (set up an account with $50 in it and you're done with membership requirements) and Quicken.

Penfed was better with rates, but I had to ride herd on them DAILY to get it done. I loved the Quicken experience - even if it was a little higher interest rate, they did it quickly and well.

Yea I forgot I got a preapproval done through Penfed as well but they aren't on top of things - someone on another thread I posted advised against them actually. I'll have to look into Quicken but hopefully my window isn't closed - I started one on 1/27 so supposedly today is the last day.

ericrugiero

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Re: Max 401k, or put towards paying off house?
« Reply #15 on: February 11, 2021, 08:20:02 AM »
You are hitting on a common debate here which is whether to pay off your mortgage or invest more.  Looking a the current mortgage rates and past performance of well diversified stock market funds it's probably better (mathematically) to invest the extra funds.  However, having a paid off home when you FIRE does dramatically reduce your expenses and is very attractive psychologically. 

I paid off my home early but if I was in your shoes (knowing what I know now) this is what I would do: 
-  Pay minimum on the mortgage
-  Max 401K and traditional IRA (and HSA if available) to get the tax benefits
-  Invest any extra money in your taxable accounts
-  Pay off mortgage just before FIRE using taxable account funds
-  After FIRE, do a Roth Ladder to access retirement funds with very low taxes

You already have enough taxable investments to sustain 5 years expenses.  Over 10 years until FIRE, it's likely that account will grow enough and you can invest enough to pay off the mortgage. 
After FIRE, you can use a Roth conversion ladder to pay for expenses after the first 5 years at a much lower tax rate than you are currently paying.  https://www.choosefi.com/how-and-why-to-set-up-a-roth-ira-conversion-ladder/
You have a good income now, very low expenses and a long time between FIRE and RMD's so you are a perfect candidate for a Roth conversion ladder. 

If you want to be sure you are able to pay off the house before FIRE, you could cut back the 401K/traditional IRA investments to be sure the taxable account has enough for 5 years expenses plus remaining mortgage.  Just be aware that will cost you in extra taxes.  It sounds like you will have enough to max everything and still save enough for the mortgage. 

Some people calculate the FIRE # with mortgage as non mortgage expenses x 25 (4% rule) + balance on the mortgage.  For you, that's $450K for expenses plus $400K for mortgage.  The mortgage balance will drop over 10 years so that will drop your FIRE #.  If you are doing a Roth conversion ladder you can count both the taxable accounts and 401K/IRA balance.  Just keep enough in taxable for 5 years expenses. 
« Last Edit: February 11, 2021, 08:22:39 AM by ericrugiero »

nexus

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Re: Max 401k, or put towards paying off house?
« Reply #16 on: February 13, 2021, 10:57:22 AM »
You are hitting on a common debate here which is whether to pay off your mortgage or invest more.  Looking a the current mortgage rates and past performance of well diversified stock market funds it's probably better (mathematically) to invest the extra funds.  However, having a paid off home when you FIRE does dramatically reduce your expenses and is very attractive psychologically. 

I paid off my home early but if I was in your shoes (knowing what I know now) this is what I would do: 
-  Pay minimum on the mortgage
-  Max 401K and traditional IRA (and HSA if available) to get the tax benefits
-  Invest any extra money in your taxable accounts
-  Pay off mortgage just before FIRE using taxable account funds
-  After FIRE, do a Roth Ladder to access retirement funds with very low taxes


What you said makes perfect sense. If I put $1k into the market, it is going to yield a higher return than I'd get from paying $1k extra on the mortgage. So the most efficient route is to put the money where it'll get the greatest return, and use those gains down the road to pay off the mortgage if it'll make me sleep better. Putting extra towards the mortgage right now is just shooting myself in the foot / slowing me down.

Edit: And yes, there's no reason I can't max the 401k and do all of the above as well -- I was more or less wondering if not maxing the 401k would somehow make things go faster -- but it won't given those pre tax dollars have the most potential to grow and compound.

nexus

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Re: Max 401k, or put towards paying off house?
« Reply #17 on: February 19, 2021, 08:35:19 PM »
Also update : I have mortgage through Wells Fargo and I have scheduled my monthly payment bi weekly ($1k every two weeks ) and the first scheduled payment was today. I am ahead on my payments (next due in April), and todayís payment was $1k principal only

The point is that thereís not some weird holding account where they take the money from my checking and donít immediately apply it towards the balance. So fear not, in that case.

Mine will continue to make principal only payments until I get near the point where the system recognizes itís time to work towards the regular payment.

So, doing biweekly payments is great and will save me in interest paid over the lifetime of the loan , without requiring additional payments/money out of pocket each month. Yay!

ryan_themoneyguy

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Re: Max 401k, or put towards paying off house?
« Reply #18 on: August 26, 2021, 09:55:24 AM »
Iíd recommend continuing to max out your 401(k). Not to say this is true of you, but the vast majority of Americans underestimate how much money theyíll need in retirement. And as others have called out, pre-paying your mortgage with such a low interest rate isnít the best use of extra cash.

Morning Glory

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Re: Max 401k, or put towards paying off house?
« Reply #19 on: August 26, 2021, 12:13:22 PM »
Also update : I have mortgage through Wells Fargo and I have scheduled my monthly payment bi weekly ($1k every two weeks ) and the first scheduled payment was today. I am ahead on my payments (next due in April), and todayís payment was $1k principal only

The point is that thereís not some weird holding account where they take the money from my checking and donít immediately apply it towards the balance. So fear not, in that case.

Mine will continue to make principal only payments until I get near the point where the system recognizes itís time to work towards the regular payment.

So, doing biweekly payments is great and will save me in interest paid over the lifetime of the loan , without requiring additional payments/money out of pocket each month. Yay!

Weird. My well Fargo mortgage did not credit the biweekly payments until the full payment was received. The only benefit was the extra payment per year. Previously I'd had a biweekly mortgage at a credit union that did credit the payments right away, but that was a true biweekly plan with 26 smaller payments instead of 12 large ones, so it didn't take any time off the loan.

nexus

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Re: Max 401k, or put towards paying off house?
« Reply #20 on: August 27, 2021, 03:25:03 PM »
Good news, I maxed my 401k this year (for the 3rd or 4th year in a row). Now that my take home pay is larger, there's plenty of extra dough to throw into investments, or pay down the house.

Other update -- I was wrong about the biweekly payment (so I stopped doing it). It just takes half the payment and holds it rather than immediately putting the money towards the balance. I should just put it on autopay and leave it, though. When you opt in, it says you'll end up squeezing in an extra payment each year but I didn't stay with it long enough to find it.

It is very likely that I'll continue to max my 401k each year until I pull the plug on full-time work. That could be as soon as 2023, or as late as 2026. After expenses are covered each month I'll probably throw most of the excess cash into investments, and maybe an extra $500 - $1000 at the house on occasion. [edit] If I quit that early, we'll still have the mortgage. I'd just ramp up my side hustle and DW would continue to work full time.

Once the portfolio reaches the point of "enough," I'll be waaay more aggressive in paying down the house, probably flipping to like 75% towards house and 25% into investing, or at least 50/50. If the market dips, I have the flexibility to revert back to aggressively investing. Same thing if the market dips tomorrow -- prioritize buying more shares on sale and throw less money at the loan.

Psychologically speaking: what's real is the $750+ I'm paying in interest each month on the loan. So far this year I've paid about $6,000 in interest. I know, I know -- my investments have grown by more than the amount I've paid in interest... and the first year(s) of the loan are where you pay the most in interest. Each monthly payment is $3 less in interested and $3 more in principal. The question is how much of my real/earned dollars am I willing to spend on interest payments at the opportunity cost of potential/very likely investment gains? $50k? $100k? $400k? I guess the question is, how many times do I [personally] want to buy my house over the course of the loan? My answer is as few as possible. The better answer is that maxing the 401k is a component of that bigger picture, as well.

In terms of the numbers, as it has been months since my initial post:
Current Mortgage Balance: $389k ][ Balance @ Feb when originally posted: $396k
Remaining income to be earned this year: 9 more pay periods @ $3,100 ea = $27,900
Wife's income to be earned this year: 9 more pay periods @ $2,250 ea = $20,250
Remaining monthly expenses: 4 months, $3k each = $12k (this includes regular mortgage payment & spending has finally slowed down)

So $50k (rounding up bc I have a side hustle) - $12k = $38k

We have $38k to play with between now and Jan 1, 2022. In the first 8 months of the year we dropped the mortgage balance by $7k, put $17k into taxable brokerage account, and $19.5k into the 401k. Wife is contributing to her 401k to get the company match, and I'm not privy to her balance yet because she is recently-eligible.

So even if I just threw another $13.5k into the investment bucket, that would be adding a total of $50k ($19.5k+$17k+$13.5k) to our investment balances this year and still leaves another $24.5k($38k-13.5k) to either invest, throw at the mortgage, or use to build up cash reserves, etc. I will disclose this has been a tremendously spendy year for us -- to the tune of about $25k in additional expenses from the new home* and paying for a long overdue wedding reception that we never got to have. Next year I imagine we'll revert to being  non-spendy pantses and we will have closer to $75k-$80k of after tax income to either invest or throw at the house.

(Big picture mentioned above) At the end of the day it comes down to currently needing a $900k stash for both of us to make work fully optional if we want to maintain the mortgage. The mathematically fastest way to do this is by prioritizing investing and not wasting additional resources paying down the house [right now]. The fastest path is to get to the $900k via investing.

Rough numbers: ~$440k retirement & non retirement accounts & the $389k owed on the mortgage.

(yes, forgot to mention we put money into a HSA as well)

*screen in deck, wrap deck, seal aggregate driveway, concrete "curbing" in yard, DIY fire pit & wall kit (from Romanstone.com), concrete slab addition to back yard & under deck; reception vendors: food truck, photographer, etc. -- all stuff that's not an annual expense.
« Last Edit: August 27, 2021, 03:26:59 PM by nexus »