Reader Case Study - how to proceed

[Neustache]

Hi all, new here, have been reading the blog for the past week.  Got a case study for ya, I am married so not all decisions are mine to make.  Decently frugal hubby, save for hobbies.

Income: 83K including bonuses from 1 full time job (DH) and my very part-time job
             8K rental income (675 per month)
             91K total (this is relatively new income for us, years past it's been at a peak of 65K)

Liabilities:

Rental Mortgage:  901 (PITI - 15 year note, 11 years left on it, balance of 69K on property worth at best 90K, 4.25 interest rate)

Home Mortgage:  911 (PITI - 30 year note, 30 years left, balance of 122K on prop worth 131K, 4.25 interest rate)

Car loan:  422  (Nissan Versa Sedan, 3 year note, 2 years left, balance of 8,500 left, hope to be paid off in August of 2014, 2.25 interest rate)

Total Debt:  199,500

No other debt.  I can give a list of monthly budget, but really it's cut down to a place where we both agree to have it cut. It includes tithing, which I don't see posted much about here, and I take would be something most would cut, but we won't.  No face punches, please (I'm asking for it, am I not? LOL)

Assets:
Nissan Versa 2012:  10K
Nissan Versa 2012: 11K (yes, we have two Nissan Versas, LOL)
Rental Property:  80-90K
Home:  131K
Checking Account Savings:  5K
Roth IRA:  6K
IRA Savings: 25K (earns a teeny bit of interest)

Total Assets: 268,000


Specific Question(s):  I'd like to know what you would do in our situation.  Our current plan is to pay down the car as fast as we can, then attack our primary home.  We don't receive much rent, but that was a calculated move on our part (got a renter right away, know him, etc.)  Plan on negotiating a higher rent, not much though, next September.  I'd love to just sell it outright, but not sure due to a lot of factors if we can.  In one year, my hubby will receive 15% of his income as a pension through his work.  So we'll start adding about 12K per year in savings. 

Our ages: Me, 34, Husband, 32.  My goal is to have to him able to retire by 50.  He doesn't think it's necessary, but I'd love for him to have the option to retire or work less.

Alright, have at it. 

[sherr]

Face punches (at least from me) are generally reserved for having stupidly high expenses. You don't list your expenses (other than your debt repayments) so it's really hard to say if / what you're doing is wrong. I can give some general topics to consider for maybe ways you can optimize your situation, but without a fuller picture of you expenses it's impossible to give real thorough advice. Do you have a lot of money left over each month or only a little?

How strapped for cash you are can make a difference on what you should do. For example you're currently paying off the car loan. Fine. I'm not saying that's a bad thing to do, but it's interesting to consider that you're actually loosing money by paying off the car loan instead of one of your mortgages since they have higher interest rates. One the other hand the car loan is a lot smaller and you can reasonably expect to pay it off in the very near future, and after that you'd have more money each month to invest / cope with emergencies. So if you don't have much extra each month paying off the car loan is probably the optimal thing to do, if you do you may have other options to consider.

It sounds like you currently are not contributing to your investments at all? You may want to consider that instead of extra principle payments on your debt. Over long periods of time the stock market averages a return of 7% after inflation (which averages at 3%), which is much better than the financial advantage given by paying off 1.25% mortgage interest (4.25% - inflation) or -0.75% car loan (2.25% - inflation, the car dealership is actually giving you money if inflation keeps to historic averages!). Know what you're getting into before you decide to invest over repaying the mortgage, after all the former is risky and the latter is guaranteed, but at least consider it. There was an interesting article posted yesterday about this very topic over at https://forum.mrmoneymustache.com/investor-alley/paying-off-mortgage-early-how-bad-is-it-for-your-fi-date/100/

An income of $91k less 10% for your tithe means you have a taxable income of roughly $82K (I'm assuming those income numbers are pre-tax?). That puts you $10k into the 25% tax bracket. This is where tax-advantaged accounts like traditional IRAs or 401ks really become magical. Every dollar you put into a tax-deferred account up to that first $10k has an instant 25% return due to you not having to pay taxes on it, the 7% per year of stock market appreciation is just gravy on top of that. You will eventually have to pay tax on money in a tax-deferred account, but it's very likely that your average tax rate in retirement will be 10% or less, and it's not unreasonable to think you'll have an average tax rate of 5% or less in retirement, depending on how much you spend each year. So looking at it long-term the benefit for investing in tax-deferred accounts is really an instant savings of 15% or more and the market appreciation of ~7%. That really is quite different than paying off 1.25% (after inflation) mortgages.

You're rental is right on the edge of being worthwhile or not. As long as the 8K a year in income pays for your interest, taxes, insurance, and expenses and still contributes something extra to your principle then technically you're still making money off of it, but it sucks that you have to pay more in mortgage each month than you receive in income, forcing you to tie up some of your other income in equity. The rule of thumb on if a rental property is worthwhile is that you should be able to get 10% of the value of the property per year in rent. It sounds like you're right about there, especially if you can raise the rates a bit next year, but it still may be worthwhile considering selling if you can and investing that money elsewhere.

My advice would be:
1) Contribute to tax-deferred accounts enough to get your taxable income down below the 25% bracket. The savings for doing this really are enormous. Sounds like you could easily do this with a couple of traditional IRAs (one for each of you).
2 optional) If you really want to then pay off the car loan. Not the most efficient use of your money, but it'd be nice to have it gone too.
2) With the money left over, sure you can repay the mortgages early if you'd prefer. Although if you're not planning on declaring bankruptcy the rental property is probably where you'd want to start, not the primary residence (same interest rate, lower balance = faster to pay it off and not have the monthly expense).

It sounds like you're really excited about paying off your debts, which is great. Consider the other side of the equation though - generating more income by investing. Passive index mutual funds are super easy to use and have great rates of return, much better than your current mortgage rates. I also understand though that there are psychological reasons for wanting to be out of debt, ultimately the decision is up to you and about what you'll be happiest with.

[MDM]

I'll second sherr's comments that
1) absent specifics, it's tough to judge what to advise, and
2) paying down the highest interest rate loan is better than paying down the lower ones

One thing on tax brackets:
    Adjusted Gross Income
-   Deductions (e.g., $12,200 is standard for married filing jointly)
-   Allowances (e.g., $7,800 for 2 people)
    ----------------
=  Taxable Income

The deduction amount can be higher if you itemize, allowances can be lower if income >$150K, etc., but to a first approximation taxable income will be $20K less than gross income.
Assuming net rental income is ~$0 then you will still be in the 15% bracket.

[Neustache]

My thinking with paying off the car first is that it give us more room in the budget once that payment is gone (should be in the next 5 months or so) which then means when it comes time to negotiate with my renter I'm in a position where I have a bit of leverage, meaning, I don't have to keep him renting if he doesn't like my terms (would like to bump it up to 775, which is not unreasonable for rent around here in a 4 bed, two bath)

I think with deductions and such we are still in the 15% tax bracket.  I'll go ahead and post our budget.  I think what we pay for sitar lessons is probably going to get some punches from y'all.  This is based off our net income, so you don't see health insurance because it's taken out of the pay, we have great health insurance.

Monthly expenses:
Rental House payment   900
car insurance      125
Peters daycAre      160
Sitar lessons                 300
Cell Phone      65.4 (1 cell phone for DH, contract up in April, checking out super cheap options, would love to get this to 20 a month)
Gas Bill                                200 (working on this.  I know, it's crazy.  But we've had the 8th coldest winter recorded.  Thermostat is at 68 right now)
Tithe                      600
Water                     63
Retirement      85 (T. Roe Price)
Internet   17th                  45 (Google fiber is coming!  Once we pay the 300 construction fee, this will be zero per month !!!!)
Netflix   30th                  8
Electricity KCPL      101 (working on this)
Food   Varies                  500 (a bit high, just started shopping at aldi's, this also includes things like TP, baby wipes, etc.)
Fast food   Varies                  50 (going to do my best to make this zero)
Car Gas   Varies                  87
Main home mortgage   981
Extra to throw at debt   1000
Car Payment      404
rachel house (donation)   150
clothes/house main.      200  (this could be lower, but we are working on two houses (rental/main)


Total:                                   6024


Okay, fire away.  :D  Thanks for the input so far.  Never would have thought about the bank paying me for my car loan, still thinking on that a bit.  And sorry for the formatting, having a hard time getting it to line up properly in the published version; looks fine in my draft. 

[MsSindy]

I'd think a little more about raising the rent by 15% all at once.  There is something to be said for someone who pays on time, doesn't trash the place, and in general is an easy renter (assuming this person is all those things).  If you have to re-rent the place, you're looking at one month's lost rental, plus advertising costs, and any general painting / carpet cleaning, etc - this could kiss any profits you would make by raising it.  Also, you never know what you're going to get with your next renter.  I would go with a much smaller increase and ensure that you do that every time the lease is up - maybe $25 or $50.  There is something to be said for having good renters, that a few extra bucks just aren't work pissing them off.

[Neustache]

Definitely something to consider, however, we were told our place could get 900 a month.  675 for a 1700 square foot house is really, really inexpensive around here.  I do agree that we want to be careful, but they knew they were getting an absurdly good deal when they rented it.  I've offered to sell it to them this year, and ran the numbers for them (with a 30 year loan, PMI, etc, they could have it at 750 a month).  But they aren't sure they want to buy it this year, maybe in a few years.  I'll walk gingerly with them, for sure.  But they shouldn't be surprised or ticked at me wanting to raise it. 

[MDM]

Somewhat of a tangential topic but it was mentioned:

And sorry for the formatting, having a hard time getting it to line up properly in the published version; looks fine in my draft.

I had the same problem, and poked around until finding something workable:
1. Create table in Excel.  Select and Copy.
2. Go to TABLEIZER!.  Right Click in the large box and Paste.
3. Click the Tableize It! button
4. Click in the box under "Copy the HTML code below:"
5. Right Click and Copy
6. Open Notepad (or Word or...) and Paste
7. Do the following edits
   -  Delete the lines from the top through the </style> line
   -  Insert a line at the top (w/o quotes): "["table"]"
   -  Delete ‘ class=”tableizer-firstrow”’
   -  Replace all occurrences "h>" with "d]"
   -  Replace all "<" with "["
   -  Replace all ">" with "]"
   -  Replace all "&nbsp;" with ""  (in other words, delete all occurrences of "&nbsp;")
8. Select all and Copy
9. Go to the MMM forum post window where you are typing your entry and Paste.  It ends up like the table below.

Looks complicated but it took more time to type the steps above than it takes to do them. 

It would be nice if the TABLEIZER web site (or some other) provided output compatible with Simple Machines table formatting but TABLEIZER seems slick as is (note: it's just something I found - I have nothing to do with it).  One last caveat: if you have < or > in your Excel table, those will be converted to [ or ] using the steps above.

Others have found ways to make their tables more legible.  Don't know what the "best" way is but would be interested in opinions.

Extra to throw at debt	1000
Main home mortgage	981
Rental House payment	900
Tithe	600
Food	500
Car Payment	404
Sitar lessons	300
Gas Bill	200
clothes/house main.	200
Peters daycare	160
rachel house (donation)	150
car insurance	125
Electricity KCPL	101
Car Gas   Varies	87
Retirement	85
Cell Phone	65
Water	63
Fast food	50
Internet	45
Netflix	8
Total	6024

[Blindsquirrel]

 Not to be a putz but unless you are getting stunning appreciation on the rental, sell that SOB! $901 going out 675 coming in? That $901 is not including repairs, expenses, capital improvements needed at some point (HVAC, roof, etc)? You have an alligator to feed, not an investment. 90K investment in a non HCOL area should kick off $1500-1800+ in rental income a month. Veteran RE investor in me says run from that! Negative $225 a month not including repairs?  If you sell at a 6K loss in 3 years you are ahead.

[Neustache]

Well, it wasn't an investement, more of a house I moved out of that I had to rent out because the home sales in the neighborhood were not great.  90K is an optimistic sales price, I have an inquiry into a realtor to give me a better estimate.  And I have a 15 year mortgage, had I instead refi'd to a 30 year I'd be breaking even (not including repairs, which I mainly to myself). There's no way that house in that neighborhood would get that high in rent - I've had a rental management company give me figures of $900.  I would love to sell it, though.  My renters want to buy it, I'm trying to encourage them to do so this year, but if they don't, well, we are going to try to work out a better rent (I am thinking $775).  The thing with my rental is that I never had to make double payments - had a renter in there the first month I was out - so while the rent is low, I know some who go 3-6 months making the whole payment on an empty property.  I still come out ahead or close to equal in my scenario versus that having it empty for months looking for a renter. 

But yes, I'd love to sell it.  Looking into it.  Really, really want to try to get the renters to buy it!

[Neustache]

Oh, and to MDM, thank you!  Much better and I'll follow your instructions next time.  Many thanks!