Author Topic: Mortgage paydown or Retirement Savings?  (Read 5038 times)

IWannaBeFree

  • 5 O'Clock Shadow
  • *
  • Posts: 9
  • Age: 49
Mortgage paydown or Retirement Savings?
« on: March 28, 2012, 09:44:50 AM »
I'm new to the Mustachian ways, and would love to get your thoughts on the below question.  I believe that my wife and I are doing many things right, but also not living nearly the frugal lifestyle that we should.  Here is some info, and my question:

Age: early 40's
Retirement funding (pre-tax): Max out 401k annually, and Max out Roth IRA (for last 3 years)  - Balance in 401k's is $400k
Taxable accounts: $50k
Debt:  only Mortgage (very unmustachian $250k on $320k home - I know, I know...i'm embarrassed - 26 years left - OUCH!!!)

Question:
Should I divert all $$ allocated toward 401k funding (above the company match limit of 5%) to paydown the mortgage more quickly (assuming no change in tax-bracket)? What if doing this disqualifies me for my Roth contribution?

I would like to work another 5-7 years, and then be truly Free!

Don't hold back!  Thanks, and loving this forum!
IWannaBeFree


velocistar237

  • Handlebar Stache
  • *****
  • Posts: 1422
  • Location: Metro Boston
Re: Mortgage paydown or Retirement Savings?
« Reply #1 on: March 28, 2012, 09:48:07 AM »
What is your mortgage rate?

Any chance you can move to a cheaper place?

IWannaBeFree

  • 5 O'Clock Shadow
  • *
  • Posts: 9
  • Age: 49
Re: Mortgage paydown or Retirement Savings?
« Reply #2 on: March 28, 2012, 11:27:13 AM »
5.25% on a 30yr fixed (with home value decline, probably only have 5-8% equity now).  We could certainly move to a cheaper place, but wife will fight it kicking and screaming due to neighbors and school district.

Ben

  • Stubble
  • **
  • Posts: 123
  • Location: SC
Re: Mortgage paydown or Retirement Savings?
« Reply #3 on: March 28, 2012, 12:14:37 PM »
Three thoughts (assuming the pushing-the-Roth-IRA-envelope situation is not hypothetical):

-If you are in the neighborhood of $170-180K in earned income (pre-tax) after contributing to your 401K, you will probably be paying more in tax on the money you are stashing in Roth NOW than what you would pay in taxes when you take it out (since you will have lower income in retirement). Even if that isn't the case, the difference will be pretty negligible, so I don't think that's a good reason to avoid a rapid home payoff.

-If you are willing to make some of the other lifestyle adjustments advocated on MMM, even to a halfway MMM and 'normal US' stance, you should be able to eliminate the mortgage entirely in just a few years, even without adjusting your 401K contribution rate. What does your monthly spending look like (approximately)?

-If you are in a higher income bracket (which it sounds like you are) you get more bang from your tax-deferred buck than the average 401K contributer in income tax savings each year, so without knowing your situation I'd be inclined to continue maxing it out.

IWannaBeFree

  • 5 O'Clock Shadow
  • *
  • Posts: 9
  • Age: 49
Re: Mortgage paydown or Retirement Savings?
« Reply #4 on: March 28, 2012, 12:51:44 PM »
Thanks for the comment.

- No, the pushing the Roth envelope is not hypothetical - Last years AGI was ~$160 (joint), and lowering 401k contribution from $17,000 to 5% would increase this closer to the $170+ (although some portion of income for me and wife is from incentive plan- so this is slightly variable). 

- I agree that we need to make some lifestyle adjustments advocated here on MMM.  Couldn't agree more.  Some of our excessive expenses include:

    - ~$650/mo Auto (gas/ins): We own 2 cars (both bought new - 3 years ago, recently paid off); we live 35 miles from both our workplaces - OUCH!
    -  ~$300/mo on vacations
    -  $500/mo on childcare
    -  $2,000/mo on mortgage/ins/tax
    -  ~$400/mo on utilities (including cable TV)
    -  ~$1000/mo on groceries and eating out - WAY TOO MUCH

These are just some of the buckets of expenses that we display our unmastacian behaviors.  I have a long way to go to completely understand our exact breakdown in all of our expences but am committed to getting there.  I have my work cut out for me in grooming my wife to see the light, and start to cut out the excess in our lives!  I lover her dearly, but she has consumerist blood running through her veins.

So, clearly I see that cutting our expenses can play a key role in MURDERING that mortgage, but was thinking that lowering my 401k contribution as low as possible (while still get company match, and not effecting Roth contribution max) to accelerate this mortgage paydown, will play a huge pyschological role in my feeling FREE. 

Time to go fill up at $4.15/gallon for that 35 mile drive home.....I just died a little thinking about that!

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28108
  • Age: -999
  • Location: Seattle, WA
Re: Mortgage paydown or Retirement Savings?
« Reply #5 on: March 28, 2012, 02:28:55 PM »
Refi to rates in the 3s (pay more to increase equity if necessary), then retirement savings once you have a super low rate.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

IWannaBeFree

  • 5 O'Clock Shadow
  • *
  • Posts: 9
  • Age: 49
Re: Mortgage paydown or Retirement Savings?
« Reply #6 on: March 28, 2012, 03:52:24 PM »
Re: refi into the 3's.   

With only 5-8% equity, I'd either have to pay PMI (which i would never do), or use about $30k of my $50k taxable brokerage account to get back to 20% equity.

smedleyb

  • Guest
Re: Mortgage paydown or Retirement Savings?
« Reply #7 on: March 28, 2012, 05:49:09 PM »
IWBF,

I think you're avoiding the unavoidable by not refinancing your house to a cheaper rate/shorter term, even if that means dipping into your taxable account and bumping your monthly mortgage to do it.  The math is pretty straight forward:  currently, you pay roughly $1380 a month, or $16.5K a year,  of which roughly 12K goes toward interest.  But putting 30K down to refi at 15 years for 3.25% drives your monthly payment up to $1540, or $18.5K a year, yet pushes your yearly interest payments to below $7K, and saves you over 200K in interest over the duration of the loan.   You go from paying $350 a month in principal to around $1000, allowing you to build equity at a much quicker pace.     

The extra 2K a year for the increased mortgage payment should be trimmed from your everyday non-essential expenses, like cable and eating out.   I think with a little work your monthly utes can be trimmed by $100 and your grocery bill by $200-$300 a month.

What about non-essentials, like clothing, hobbies, gifts, etc?  I'm trying to get my wife to be a more mindful shopper, which has actually freed up a couple hundred every month.

Keep on maxing out the retirement accounts and find creative ways to trim spending while plowing those savings into rebuilding your depleted brokerage account.  For example, check out some travel reward cards in order to get some free hotels/rentals/airfare to trim your travel expense.  My family for the past couple of years was spending a very unmustachian $1K a month on vacations -- hockey game in the big city, trips to Florida, the Bahamas, etc; don't think you're the only one failing in areas you know you can do better.  But now that we've addressed our psychological need to travel/escape in style, coupled with some travel rewards cards, that number will be chopped down to around $400 a month while increasing our actual vacation time (less Disney, more visiting friends and family out West, deep South, etc).

Trust me, I listen to your financial situation, from the house to the savings to the expenses, and I see my own.  Early retirement means tackling that mortgage head on, and it starts first with a lower rate/shorter term.

Best of luck.
« Last Edit: March 28, 2012, 05:54:44 PM by smedleyb »

sol

  • Walrus Stache
  • *******
  • Posts: 8493
  • Age: 42
  • Location: Pacific Northwest
Re: Mortgage paydown or Retirement Savings?
« Reply #8 on: March 28, 2012, 06:49:16 PM »
By way of contrast, I'm in the same boat of having to decide between saving for retirement or putting up principle to buy enough equity to refinance to a lower rate and I'm saving rather than paying down the mortgage.

In our case, it makes more sense to carry the mortgage for a while longer.  Our rate is at 4.875% and we could get it down to about 3.5% by going to a 15 year, but it would cost like 20k out of pocket to hit 80% LTV to be able to refinance.  Since we're only at about 85% and I expect housing to recover before I expect rates to rise, I think we're better off continuing to pay on our current 4.875% while building equity, and wait for the house to appreciate 5% before mortgage rates rise.  This means carrying our current mortgage for another year or two and THEN refinancing.

The Fed says interest rates will be low at least through the end of 2013.  I don't feel rushed to refinance right away.

smedleyb

  • Guest
Re: Mortgage paydown or Retirement Savings?
« Reply #9 on: March 28, 2012, 08:29:56 PM »
Sol,

If you put down an extra 20K, and refinance your mortgage for 320K at a the lower rate, you go from paying 4.875% on 340K, or about 16K in interest, to paying 3.5% on 320K, or 11K in interest.  That 20K (+ refi fees) will net you about 5K a year in interest savings, or roughly a 25% return on your money. 

That a solid return.  Don't get me wrong, I love liquidity and pumping my brokerage account full of money too, but 25% is very juicy.   

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28108
  • Age: -999
  • Location: Seattle, WA
Re: Mortgage paydown or Retirement Savings?
« Reply #10 on: March 28, 2012, 10:03:36 PM »
Re: refi into the 3's.   

With only 5-8% equity, I'd either have to pay PMI (which i would never do), or use about $30k of my $50k taxable brokerage account to get back to 20% equity.

Yes, that's why I mentioned paying more down to increase your equity.  You're right, you absolutely shouldn't do PMI.

The original question (in the title) is pay down mortgage or retirement savings.  Clearly you're looking at paying it down as an option, so why would paying it down to increase the equity enough for a refi be bad?

The others did the math, but it makes sense to pay it down, refi, then save for retirement.

I think it's fairly cut and dry.

Option 1: Leave house as is, increase retirement savings as much as possible
Option 2: Pay down house, refi, then go for as much retirement savings as possible
Option 3: Pay down house, refi, then continue to throw everything at mortgage.

If you're super debt adverse and want the peace of mind and don't care about the mathematically superior way, then you go #3.  If you're okay with debt at low interest rates and want to maximize your money, you go with #2.

#1 is the worst of both worlds, you keep debt, and at a higher interest rate.  Option 2 and 3 have been debated back and forth on the forums and internet as a whole, do you pay down mortgage or invest?  That's a personal choice.  But either way the superior choice is first to pay down the house and refi.

Hope that helps!
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

IWannaBeFree

  • 5 O'Clock Shadow
  • *
  • Posts: 9
  • Age: 49
Re: Mortgage paydown or Retirement Savings?
« Reply #11 on: March 29, 2012, 07:41:56 AM »
Thanks again for the great dialogue, and helping me confirm what needs to be done.

Option 1 above, is definitely not the path for me.

While I'm averse to trimming my stash by depleting my taxable brokerage account from $50k to $20k, I do realize that refinancing to a 15yr mortgage is the best finanical decision.  Therefore, my approach will be to

1. Keep maxing out 401k's
2. Cut the fat out of my monthly spending to the tune of $1,000/mo (painful, but know it needs to be done - I've been avoiding the innevitable!)
3. Refi with principle from taxable acct (paydown to 80% LTV)
4. Use the free'd up monthly funds to pump the taxable account back up to $50k+
5. Then start to chip away at the mortgage even more - and see if I can pay it off by my targeted Indpendence Day January 1, 2020!

Thanks again!

Physics

  • 5 O'Clock Shadow
  • *
  • Posts: 81
Re: Mortgage paydown or Retirement Savings?
« Reply #12 on: March 29, 2012, 08:51:04 AM »
That sounds like a very logical plan, nice work!

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 28108
  • Age: -999
  • Location: Seattle, WA
Re: Mortgage paydown or Retirement Savings?
« Reply #13 on: March 29, 2012, 09:00:23 AM »
Refi-ing to a 30 is fine (and my flavor of vodka), just refi so you get a lower interest rate.  Whether you decide 15 or 30 is another personal choice.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Ben

  • Stubble
  • **
  • Posts: 123
  • Location: SC
Re: Mortgage paydown or Retirement Savings?
« Reply #14 on: March 29, 2012, 10:21:38 AM »
IWBF,

Sounds like a good plan, best of luck as you carry it out! Keep us posted as you go through the process!