Author Topic: Pay off loans or save for downpayment before market takes off?  (Read 3124 times)

LucyBIT

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Hello, Mustachians! I've been mostly lurking around here, but I finally signed up and now I'm hoping to get some of that delicious MMM advice that gets doled out so often. And accept facepunches, of course (what is life without facepunches?).

My fiance and I are cutting down our expenses and we've made a lot of progress. I've gotten him to concede a few things and I'm hopeful he'll concede a few more as we move along :)

The issue, though, is that we need a plan for what to do with the money we're not spending. Fiance is a self-proclaimed lover of spending, and I'm worried he'll lose motivation if we don't have a specified goal. Right now it's just going in a savings account, but I can already see him wavering; "spend less money" isn't enough for him, he needs to be able to think "put this money toward X instead of Mountain Dew".

SO. We have the three Big Ones that so many others do:
- Student loans
- Desire to buy a house
- Desire to save/invest for retirement

My gut feeling is to pay off the loans with all possible speed, then split between saving a down payment and retirement investing. But there are a few complications, so let's throw it down and see what the Mustachians think!

Student loans:
$24,474 at 4.75% (Federal consolidated)
$28,161 at 4.5% (Private unconsolidated)

We can easily pay these off in under 2 years, then save a 20% downpayment in about another 2 years (this assuming the status quo, i.e. no job changes, job loss, raises, significant health expenses, etc., but we are pretty securely employed at the moment, fiance gets regular raises, fiance has HSA and we have emergency funds set aside, so this is a reasonable estimate).

Where I'm getting stuck is that I'm afraid if we wait 3-4 years to buy a house, we'll be left behind by the growing housing market in our area (Lakewood, CO). Fiance's parents are also convinced that we need to buy in the next 18 months or we'll get screwed on prices and interest rates and waste money on rent, and they do have a point--rents are high and if we had 20% right now, it would definitely make more sense to buy than continue to rent. I personally don't consider rent money 'wasted' or 'throwing your money away', because it's purchasing shelter etc., but with prices and rents where they are right now, we could definitely be using the money more efficiently.

But Fiance's parents are so desperate for us to buy a house that they say we don't need 20%, and they've even gone so far as to inform us of 3% down loans (FHA, maybe?) and suggest we take out 401k loans to cover a down payment (we literally laughed out loud when they told us this).

We have no assets, essentially:
~$3,000 combined in our 401ks
a car that we owe ~$12,000 on (1.9%, Edmonds says private party sale it's worth $19,000)
~$10,000 across checking and savings accounts

That's it. I feel like it's astoundingly foolish to borrow six figures when our net worth is around negative $60,000, but I don't know how to communicate this to either fiance or his parents (his parents I don't care that much about convincing, it's obviously Fiance that matters). His parents are gifting us $10,000 for our upcoming nuptials (which will cost less than $5,000 and be paid for using funds we've already saved), and it's very clear they think that takes care of half a down payment. I don't think they know exactly how much I owe on my student loans, though.

A note about the car: it's a 2012 Subaru Forester that Fiance will not even consider getting rid of right now. I recognize that it's an obvious piece of fat that could easily be trimmed from our budget, but after several rounds of fighting over it I've decided to back off for the time being. If Fiance saw us as being in true financial straits, i.e. it's the car vs. continuing to pay a mortgage or something like that, he'd get rid of it; he regularly checks its resale value, keeps up on the maintenance, and tries to keep the milage in check to stem depreciation. At this point in time, the car is off-limits, so while I'd appreciate any suggestions to help convince him otherwise, telling me that it's a drain on our finances is something I already know and can do little about, so not a lot of help :)

I guess my questions are:
1) How much would house prices and interest rates have to rise in the next four years to make waiting to buy turn out to be foolish?
2) How do I do the math on this to convince Fiance if I'm right and we should wait?
3) Are the interest rates on my loans low enough that I'd be better served going for the house and/or investing? We're 30 and have basically no investments, and I worry that waiting will hurt us.
4) To complicate the matter further, because of my age and various health reasons that I'd rather not go into right now, we're verging on "now or never" when it comes to having children. So there's the possibility of adding a kid or two (twins run in my family) right around the time we'd be paying off the loans (if we choose to focus there), meaning we'd take even longer to save the down payment (whether I keep working or stay home is only slightly relevant; either we'll have daycare expenses and my take-home drops 50% or more or I stay home and my take-home drops 100%. either way, the down payment will take longer.).



Scenario #1:
Put $10,00 from Fiance's parents into loans, pay off loans in ~18 months, then start splitting between down payment and increasing 401k contributions.

If we have a child at this point, I can stay home and if we make more changes like finding a lower-rent place and continuing to cut down expenses, I can feasibly see still saving for a down payment, paying extra toward the car loan, and saving for retirement (if I quit my job I would roll my 401k into Vanguard and could continue adding at intervals when possible). Everything would be slower, but not having the student loan payments would help.

If I keep working, we can do it faster. But if we have twins, based on average childcare costs here (Colorado, 4th-highest in the nation), we'd be paying more than I'd earn if you account for disposable diapers and formula (if I stay home I can cloth diaper and breastfeed, but it's my understanding that while you can usually find a daycare provider that accepts pumped breastmilk, finding one willing to cloth diaper would be a lot harder). I'm not assuming I'll have twins, but there's a greater-than-normal chance of it, so I want to consider it a possibility.

Regardless of whether or not I stay home, having those loans gone would give us more of a cushion, and Fiance is freaked out about the cost of having kids anyway (I'm not; my parents raised 7 on 1 income that never hit six figures. I know it can be done frugally.).



Scenario #2
Continue paying minimum payment on loans plus a little extra, save for down payment, put $10,000 gift into house fund. In 18 months, buy a house.

If we have a child at this point, we would now have that child to care for, so add in all the considerations from scenario #1, plus the $480 minimum payment for the student loans, plus a mortgage, plus if we go with less than 20% like Fiance's parents are pushing for, PMI.

This scenario terrifies me, frankly. We'd be locking ourselves into a level of spending I really don't like. But am I just being a complainypants? Again, if we end up with twins, we would be paying for me to continue working, so if we go with Scenario #2, we're essentially banking on only having 1 child, which, again, is the most likely but not only scenario for my reproductive parts.



Looking at my scenarios, I feel I may have answered my own question; opting to wipe out the loans will put us on steadier ground and give us a better baseline for future savings and investments.

But I guess it comes down to the first question, how much would interest rates and house prices have to rise to make us regret going with Scenario #1? Are we already too late? Can we even get a favorable mortgage with a net worth of -$60,000, even with my excellent credit score (800s)? And is 4.75% low enough that I'm foolish to not choose a Vanguard index fund or increased 401k contributions (we're currently only at employer match)? Am I making this too complicated (probably)? Do you need more numbers?

Thegoblinchief

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #1 on: April 01, 2014, 10:36:03 AM »
I really wouldn't recommend doing loans without 20% down in today's climate, where PMI is permanent without a refi.

The SLs are a low enough rate that I wouldn't prepay them regardless. Maybe prepay the 4.75, but not the 4% one. You should be maxing out retirement accounts instead of prepaying those.

Are you going to be in Lakewood for 5+ years? Jobs stable? Explore the house market. Talk to mortgage brokers, get a pre-approval. Use all of this data to get a clearer picture. DEFINITELY DO NOT BUY A HOUSE BECAUSE YOU "HAVE" TO.

Others have vastly more experience with real estate than I do, but 'timing' a real estate market is just as dangerous as timing the stock market, IMO.

Consider also whether you are truly compatible financially and discuss NOW how you are going to structure your finances.

Threads worth reading:

http://www.mrmoneymustache.com/forum/welcome-to-the-forum/divorce-wmfd-%28weapon-of-mass-financial-destruction%29/

http://www.mrmoneymustache.com/forum/ask-a-mustachian/combining-finances-after-marriage/

I feel like there was a more recent thread about joint finances than that second one, but can't seem to find it.

Edit: More threads

http://www.mrmoneymustache.com/forum/ask-a-mustachian/implications-of-partnerships-with-different-sized-mustaches/msg243983/#msg243983

(This is the one I was looking for) http://www.mrmoneymustache.com/forum/ask-a-mustachian/separate-finances-and-marriage-vows/
« Last Edit: April 01, 2014, 10:38:16 AM by Thegoblinchief »

Everything in Moderation

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #2 on: April 01, 2014, 10:56:47 AM »
I am in a very similar situation and would strongly suggest that you do not buy now.  Yes interest rates will go up.  BUT you are not ready to buy and house, and that is step one.  Only buy a house with 20% down, you will regret the FHA!

I think your st. loan rates are pretty high.  Mine are at 2.1 and 3.1%.  I would start paying those down and start investing your money.  In 4 years, you can pull some of that money out for a downpayment.  Never rush into buying a house, ever!

Take the gift from your in-laws and either pay off loans or invest.  They don't need to know what you did with it.  Spend the next year or so working with and talking to your husband and money, financial goals, and what your family spending plan will look like. 

You are about to start a family and this is even more reason to be cautious. 

MDM

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #3 on: April 01, 2014, 11:11:23 AM »
First, best wishes for your upcoming marriage. 

See http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers for some thoughts on your question.  One thing you and your fiance should discuss about buying a home: are you doing it as an investment vehicle, or due to its location?

To your questions:
Quote
Looking at my scenarios, I feel I may have answered my own question; opting to wipe out the loans will put us on steadier ground and give us a better baseline for future savings and investments.

But I guess it comes down to the first question, how much would interest rates and house prices have to rise to make us regret going with Scenario #1? Are we already too late? Can we even get a favorable mortgage with a net worth of -$60,000, even with my excellent credit score (800s)? And is 4.75% low enough that I'm foolish to not choose a Vanguard index fund or increased 401k contributions (we're currently only at employer match)? Am I making this too complicated (probably)? Do you need more numbers?

I agree that you answered your own question correctly.

You can always find things to regret about decisions: hindsight glasses are the most amazing things.  But only you can answer the "how much" part.

Talk with you local bank, credit union, PenFed, Quicken Loans, etc. about what kind of mortgage you can get.  Different lenders may give different answers.

See http://www.mrmoneymustache.com/forum/investor-alley/differing-schools-of-thought-invest-up-to-match-or-max-out/ for more details on your 401k vs. SL vs. Vanguard question.

In sum, you seem to have good instincts.  Trust them.  You will not achieve perfect results - but don't regret a lack of perfection when things are actually ok.

nawhite

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #4 on: April 01, 2014, 12:40:06 PM »
First off the best Rent vs Buy Calculator for convincing people one way or another is here: http://www.nytimes.com/interactive/business/buy-rent-calculator.Html
Be sure to change the default advanced settings to match your situation. (for instance, CO property taxes are like 0.7%)

I just bought in Denver with a Conventional Mortgage (not an FHA) with 10% down. Our PMI will automatically be removed when we get to 78% LTV or at 80% if we ask them to remove it. No refinance required. So don't feel like the only options are 20% or FHA, you won't know until you start getting quotes.

Are the student loans a fixed or variable interest rate? 4.75% fixed might not be worth paying down early, but 4.75 variable probably would.

Before you start debating putting money into loans or savings or investments, make sure that first thing you are both contributing to your 401k up to your employer match. Way better deal than anything else.

As for the Colorado housing market, I'm fairly bullish on it, but there is a ton of construction going in now that should cut prices soon. Basically the supply of houses for sale (and rentals) has been very low for the past 2 years. Little construction was done during the recession and many more people were underwater and thus weren't selling when they otherwise would have. Those 2 problems are being fixed (by rising home values and new construction) so personally I'd expect prices to start to level off or increase at a normal rate (not the 20% year over year we've seen in some places recently).

LucyBIT

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #5 on: April 01, 2014, 01:08:15 PM »
Thanks for the reply, Thegoblinchief. You neatly got at the subtext of my OP, which is that my fiance and I are not on the same page here. I'm talking about saving vs. investing, and he just wants me to tell him how much he can spend on entertainment every month.

And I do need to do more research. PMI is not something I want, but I don't have enough information under my belt to debate anyone over it :D I have a credit union picked out that I need to confirm I qualify for anyway, and we've been talking about meeting with a mortgage broker over there.

Everything In Moderation, that is exactly how I feel--as MMM says on the blog, if we don't have the discipline to save a down payment, we don't have the discipline to be homeowners! Fiance's parents are in their 60s and well-off, and have owned multiple properties including vacation rentals. They're in a completely different place than we are.

And without having done any math on this, I feel like if house prices go up so much in the next few years that it turns out to be a significant difference having waited, that's another housing bubble, so we'd want to hold off then too!

I know a lot of people post in here about student loans, but I've yet to see anyone with similar interest rates; I usually see either 2ish or 6+, and in those cases it seems obvious what to do. But for me, I know 4.5% could be considered high, and if it's 4.5% interest vs. 0.9% in a savings account, the loans are the clear winner, but if it's 4.5% interest vs. long-term investment gains and dividend reinvestment, I become unsure.

I am less troubled about the 4.5% loans; since I never consolidated them (I have 4 smaller loans that make up that total, but they are all at 4.5%), my monthly payment is higher but I'm paying more principal and the amount of interest I'll end up paying isn't as bad. The 4.75%, however, I consolidated with 25-year extended repayment a few years back when I needed to lower the monthly payment, so each minimum payment is going more toward interest than principal. I'm currently paying an extra $200/month, which Mint tells me will save me 12 years and over $8,000 in interest, which brings me some peace of mind, so I'm at least going to keep doing that.

I'm not 100%, need to figure this out, but I believe that when I consolidated my federal loans, I locked in the 4.75% rate. I also believe the private loans could potentially rise, which is why I don't have them set to pay automatically--going in there every month to make a payment forces me to check the interest rate on a regular basis.

nawhite, thank you so much for responding. I really appreciate some Denver perspective on this. Rents have been so high in the past few years, but I do believe they are going to level off or go down as more people buy and all these shiny apartment buildings I see going up everywhere start filling up. So while we may have already passed the point where we can save a ton by buying instead of renting, I hardly see how that's relevant to future decisions, and going forward it could end up benefiting us. My future brother-in-law's friend just bought a house in the area we're looking at, and apparently the value of the house rose between the time they went under contract and closing, but I can't see that as sustainable or a reason to rush into anything.

We are both at employer match in 401ks, which is 6% for Fiance and 4% for me.

I have run the NY Times rent vs. buy calculator, and based on our price range and 20% down, it says buying will be better after 3 years (we're going for less than $200,000, in fact I saw a listing the other day that was exactly what and where we want for $180,000, so that would be even better). We wouldn't plan on leaving for at least 7 years, and probably more like 10--all of our family is in the area, we love it here, and in Fiance's line of work, he can basically continue to get jobs in downtown, and we're hoping to buy along the light rail.

soccerluvof4

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #6 on: April 01, 2014, 01:28:15 PM »
Its been said on here but to be blunt

Dont buy a house because of what one might think could happen. Thats ludicrous with the debt you have. Personally, I would find a balance of paying down debt and saving. When the time is right THEN and only then buy a home and when your married.  Sounds like maybe your Fiance needs a few face punches as well. I would make sure he is on board and not convince yourself of that as well before even contemplating going further in debt!

Finally, dont let in-laws run your life,,,,they wont stop!

Thegoblinchief

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #7 on: April 01, 2014, 02:38:25 PM »
Definitely kill the 25 year amortized SL. Good instinct there.

From the numerous other threads I've read/commented/participated in, 4-5% debt is the borderline area. Some argue for paying it off early, others argue that anything below 5% is worth keeping around.

If you're inclined to pay it off early, go that route. Historically speaking, we're talking an average of 1% annual returns after inflation you are leaving on the table. But, like you said, BOTH investment AND repayment are better than savings idling at 0.9% unless you really, really must have that house.

LucyBIT

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Re: Pay off loans or save for downpayment before market takes off?
« Reply #8 on: April 01, 2014, 05:24:54 PM »
I just double-checked, and the 4.75% is fixed, 4.5% is variable. Doubly glad I check it monthly!