Pay Off Mortgage with Inheritance?

[Grindela]

We live in Oakland CA, a nice temperate climate and we garden year around.

We bought a fixer-upper house 15 years ago.Our monthly mortgage is cheap at $547 a month, but we are paying something like 6.2% interest, and still owe 72,000 on a 92,000 loan.  My husband, though disabled,  is very handy and redid the entire interior himself but then had trouble pulling permits to redo the exterior. These troubles dragged on for years. The city planners were never the same person and kept sending him home to make more and more detailed drawings. We finally figured out that they probably don't want home owners to work on their own place in this town.

3 years ago, through the city, we got a 0% no-interest loan (which in the end, totaled 120,000) to finish the major exterior foundation and safety stuff that our house required. The good news is that, we don't have to pay that $120,000 back until we die or sell the house. Our house is now worth about $372,000. The bad news is, that the contract with the city stipulates that we can not refinance the first loan without paying back the city. In other words we can't lower that 6.2 percent interest.That's a lot of money in interest.

My husband inherited $90,000 in stocks from his grandmother a few years ago, which is being managed by her financial adviser, and is now $112,000. We know very little about investing money, inheritance tax, and I make 42,500 a year as a teacher, and would like to retire as soon as possible. My husband has medical issues and is self-employed as a carpenter when his health allows it but doesn't have a steady income.

Our question is, should we use part of his inheritance to pay off the 72,000 we owe on our mortgage with the 6.2% interest. If so, what kind of inheritance penalties might we incur? Also, this financial adviser advises us not to do anything with the money but let it grow but of course he pays himself something for his skills.

We are frugal people in the sense that we shop in thrift stores, have been driving an old pickup for 20 years, grow as much of our own food as possible, and raise chickens and bees. We like where we live. Our credit card debt is minor, 2,000 due to the fact that we fly to see our parents on the east coast once a year, which is too expensive. We're taking a few years off on that until we become more financially solvent. I have 36,000 saved in my 403b plan.

Needless to say, I want to retire ASAP but first have to save more money and  learn something about money management. But my first question is, would it help us to pay off our mortgage with his inheritance?

[Joel]

You will have to pay capital gains on the growth since you inherited the investments, but you can get a guaranteed 6.2% return by paying off the mortgage. I think it's worthwhile to do.

There are no penalties that you have to pay regarding the inheritance. That happens before you receive the money.

[Another Reader]

Do you have a pension?  Social Security?  With so little saved for retirement, credit card debt, and no other savings, I would not pay off the mortgage.  That converts liquid savings/assets to trapped equity that cannot be accessed under any condition because of the City limitations on financing.  Instead, I would approach the City to see if they would modify the contract to allow you to refinance the existing principal balance at a lower rate.  Often these sleeping seconds have provisions to allow this, because the idea was to give moderate income folks some assistance while revitalizing the housing stock in the area.

In the meantime, review your expenses to see where the money is going.  See if you can find a way to increase your contributions to your 403 b.  If your husband has earned income that appears on the tax return, then he should try to fund an IRA.  With your limited income, you need to save as much as you can to have a reasonable retirement.

What about health insurance?  Is your husband getting insurance through you?  What happens when you retire - will he still have access to affordable insurance?

There is no inheritance tax for you to pay.  If the money in taxable accounts, any dividends or capital gains would be taxable.  Likely your income puts you in the 15 percent bracket, meaning they are taxed at zero percent.  If it is in an inherited IRA, there would be required minimum distributions.  Those would be taxable as income.

[Gin1984]

So you owe $190,000 on a 372,000 house.  Make only $42,000 in the Bay Area (an extremely high cost of living area), have credit card debt and even with the inheritance you only have about $148,000 for retirement?  Wow, and how soon do you want to retire?  What percentage do you put aside for retirement per year? 
Personally, I'd pay off your credit card debt, set aside some money for an EF, build a budget, and start moving the money into you 403b and Roths?

[warfreak2]

So you owe $190,000 on a 372,000 house.

Rather, they owe $72k on a ~68% share of a $372k house, but the city owns the other 32% and lets them live rent-free in it, until they die. That's a pretty good situation, I'd say!

I vote pay off the rest of the mortgage immediately, along with the credit card. A "cheap" monthly payment is irrelevant, what matters is the interest rate which is relatively high. I also vote, don't touch that 0% loan any more than you need to.

[SDREMNGR]

I would HIGHLY advise the following in order of importance.

1. Take the money away from the adviser and put it in a Fidelity account (I'm in Vanguard but I miss Fidelity).  That should start saving you money right away.  Put it in a 70/30 mix of VTI and BND.  Given your age and probably lower risk tolerance, it would be a simple and easy ratio to re-balance once a year.  Do this ASAP so you can stop paying this advisor any more money!  If you request a transfer of the assets held by the advisor "in kind" and don't sell out of it to transfer, you should be able to do it without triggering any capital gains.  You are just changing who is the custodian of the funds from your advisor to Fidelity.  You will have to pay capital gains on the amount you will need to sell to do #2 and #3 below.
2. Pay off the credit card debt.  Rule #1 of personal finance is "NEVER CARRY A CREDIT CARD BALANCE EVER!" Rule #2 is "NEVER CARRY A CREDIT CARD BALANCE EVER!".  Rule #3 is look at rule #1 and then rule #2 and then slap yourself silly if you broke rule #1 or rule #2.  Regardless of whatever the "need" is, it should never come at the expense of a 20% interest credit card loan.
3. Pay off the mortgage in full using the inheritance.  Yes, as some have pointed out, the money will be sitting in your house but you will have made 6.2% on the money guaranteed and given your financial history, I don't think you are too much into fancy financial engineering or having to think about money too much.
4. Put the money that you USED TO put towards your mortgage into your Fidelity account and keep investing it.  You probably don't have a Roth IRA so you should invest $5500 per person into it ($6500 if over 50).  It's easy to set up.  It's different than the money from the inheritance, which will sit in a taxable brokerage account.  Fidelity can also set this up for you.
5. You seem content to live out the rest of your life in your current house so you are all set there.  No need to pay off any of the 0% loan ever.
6. Start saving up as much as you can between now and retirement in you and your husband's Roth IRA account.  With a limit of $11,000-$13,000 / year, it looks like you won't be hitting the limit soon, so it'll be plenty for you to invest through.

Good luck!

[Grindela]

Thank you, great idea- I will ask the city if I can refinance to lower my interest rate. In our experience they have been more of a stonewalling system of rules, but we will see if they will listen to reason.

I have a small pension which would pay me $800 a month if I retired next year at age 55, and 1560 if I retired at 60, and 1985 a month if I retire at age 65. I have been working at this state teaching job for 12 years. However, they are looking to outsource my job in a year or two, which is of concern.

My husband is on my health plan. IF I am there 20 years, I will get free healthcare after retirement and we will pay something for him. He doesn't work enough on the record to pay taxes.

I think we could save a bit more money f we cut out certain health expenses such as going to a therapist- however therapy has helped him make progress in his disability so that he has been able to work more. So quality of life for him in that respect is important.

Our other expense is that we have two cats and two dogs, and chickens. Their food comes to about 100 a month.

Our expenses in May:
Doctor/Health/Pharmacy $276
Groceries $187
Restaurant $90
Gas 86.
Clothes 73
Netflix 15
Geico 40
Cell phone 30 and 15
Mortgage 646 (I pay 100 a month extra towards principal)
AT & T internet/landline 90

I owe 2092 in credit card debt.

I need to save for property tax in November, and April about $1179 each time.
Also, an emergency fund in case I lose my job.

Biking to work is physically challenging right now- 7 miles of hills and freeways and I need to get there by 7:15 AM. Buses are more doable at $2.10 each way.

[Grindela]

Thank you for all of your support and financial logic. I realize my financial dealings are a bit bat shit crazy, but the good things are worth shifting around.

I totally appreciate it. I will work on this, I think paying off the mortgage and reinvesting the money is a good idea... SDREMNGR, warfreak2, Joel.

Peace.

[Another Reader]

You live in a high COLA area and have no significant savings or other assets.  Trapping the equity so that it cannot be accessed for any reason without selling makes no sense.  You have no flexibility and could be forced to sell the house to meet any number of emergencies.  Negotiating with the City to refi the remaining balance is worth a shot.  If the negotiation fails, it still makes sense to invest in retirement accounts, taxable accounts, and cash savings before the mortgage.  And, yeah, the financial advisor should be replaced with either Fidelity or Vanguard and self-management.

Your numbers show you MUST start saving more for retirement.  You can't afford the house and eating on the pension - the house alone will be more than your pension if you retire next year if you include taxes and insurance.  Paying it off does not help much - you still have to pay taxes, insurance, utilities, and you have to eat and pay your other expenses.  Do you or your husband have Social Security? 

I forgot that your husband can open a spousal IRA based on your employment.  Maybe every dollar he earns can go to this?

In your shoes, I would stop paying extra on the mortgage and get rid of the credit card debt ASAP.  Unless you are at zero percent interest, it's a poor use of your limited resources to make these payments.

Finally, what are your employment prospects if your job goes away next year? 

[Grindela]

I see your point.

I'm putting 10% of my monthly pay into my 403 b. Would it better be put into a Roth account?
I have social security, he does not.
We will inherit from our parents at some point, thank goodness.

I am a seasoned early childhood teacher with excellent references, however the pay is even worse, outside a state run program such as the school district or university. I'd get a job but perhaps not as convenient to where I live, and perhaps without benefits for my husband.

[Bearded Man]

I would pay off the morgage, sell the house for what is a very nice gain, then relocate to a lower cost of living area. You would in effect be able to pay back the city, buy a good house in a low cost of living area and still have well over 100K left over for retirement savings and emergency fund.

Too often people put themselves in a situation where their life is unecessarily difficult simply because they will not cash out and relocate.

[former player]

Since you haven't mentioned that you have been taking income from the inherited investment fund, I'm assuming you haven't been.

My preference in your situation would be to use most of the investment fund to pay off the credit card and mortgage.  Regarding the mortgage, you are settled and happy in your house and garden, and in fact have a financial subsidy (interest free loan for life) to live there.   That's the best housing deal you are ever going to get (not the cheapest, but the best), and my view is that paying off the mortgage on the home you want to stay in makes your future as secure as it ever can be.

If you pay off the mortgage, your income instantly increases by $646 a month, which is approx. $7,600 a year.   That is enough to pay an annual airfare to see family, to put something into emergency funds and a car replacement fund and to put regular contributions back into your investment fund.

Move the rest of the fund into a better investment which you manage yourself.  Plenty of advice from Mr Money Mustache and on this forum, which you should be able to pick up on pretty quickly.  How is the $36,000 in your 403b invested?

On the income side, if your job is outsourced, can you get a different role within your existing organisation (eg start looking at what might be available and position yourself for it) or keep your existing role by moving across to the new organisation?  Are Medicaid/social security/disability currently available to your husband?

[Another Reader]

Do you have any idea how much you will get from Social Security? 

There are a lot of free on-line retirement calculators, simple and complex.  You can get a Social Security estimate by going to ssa.gov and setting up an account.  The software will enter your lifetime Social Security earnings through 2012 and you can enter 2013, 2014, and what you estimate for 2015.  They will estimate your payments for 62, your full retirement age, and age 70. 

Your 403b defers the taxes until you take the money out.  A Roth IRA is funded with money that has already been taxed.  You are in a low tax bracket now and you will probably pay less tax in retirement.  To me, deferring any expense now so you can build up assets makes sense.  At your income level, you and your husband probably qualify for traditional IRA's, which are also tax deferred.

Is your agency part of the State or is it State funded?  Does your agency participate in CalPERS - is that the pension you will receive?  If your job is outsourced, moving to another State agency or a local agency that is a CalPERS participant would allow you to build up the time in CalPERS and increase your total pension benefits.

In your shoes, I would think about paying off the mortgage if/when you receive the expected inheritances.  It might make sense if the amounts are significant to pay off the 6.2 percent loan then.  Until then, I would preserve the liquid assets and work on planning and funding retirement.

[Grindela]

Social Security: if I retire at 67, $1,400 a month. Ahe 70, $1830.  At 62, $884 amonth.

Yes, I am part of Calpers. If the outsource occurs it would be wise to get a job within that system for sure.

Good compromise, waiting to pay off mortgage when there a bit more money comes. Thanks so much for presenting your view.