Strategy for Personal/Business Debt & Investing

[RockYourSocksOff]

I am trying to strategize how to best attack my debt while still setting money aside for retirement and college for the kids.  My wife and I are both 30.  She works and I'm self employed.  We have three small children ages 0, 2 and 3.  I've read a fair amount about paying down debt (specifically Dave Ramsey's Baby Steps) but I really don't understand how to best employ these strategies when there is business debt in the mix.  Our only personal debt is our mortgage and a mortgage on a rental property that currently shows a small profit annually.  Otherwise we have no car payment, credit card debt or student loans.  The business has two term loans that were used to start the business and also a truck payment.  I'm trying to decide whether it makes sense to attack the business debt or pay down the mortgages.

• Business Loan 1: $75K @ 5.25% with $2,330 per month payment
• Business Loan 2: $12K @ 5.65% with $1,150 per month payment
• Company Truck Loan: $20K @ 2.39% with $415 per month payment, NADA trade-in value is around $30K
• Home Mortgage: $167K @ 4.75%, tax assessed at $171,500, PMI was prepaid
• Rental Mortgage: $112K @ 3.75%, tax assessed at $99,400, PMI goes away at $93K balance and costs $100 per month

I am currently making my payments on this debt with no trouble and would like to accelerate the process.  My wife contributes 5.5% every month to a company retirement plan and receives an 8% match.  We then put another 9.5% of her income into a Roth IRA.  I put 15% of my gross income into a SEP IRA every month.  None of the retirement accounts are ever maxed out in a year though I expect the Roth to be maxed out this year.  We put $150 per month total into 529 accounts for the kids.  We also have approximately 4 months safety net in cash and minor non-qualified investment accounts that could be accessed.

The business is an S-corp and I'm the only officer so the business finances really are part of my family finances when it all boils down.  I would like to pay down the debt as efficiently as possible.  That being said, I also want to invest while I am still young enough to see serious returns in my lifetime.  While it seems that the business debt should be paid off first there is an SBA guarantee on the larger balance if there were ever an emergency and I'd really like to get rid of PMI on the investment property.  A major goal of mine is to purchase more investment properties as soon as possible without sticking my neck out unreasonably.  Any and all input is appreciated.  Thanks!

[MDM]

If you haven't already, you could use something such as http://www.vertex42.com/Calculators/debt-reduction-calculator.html (downloadable Excel file) to evaluate the interest cost of different payment options.

[RockYourSocksOff]

If you haven't already, you could use something such as http://www.vertex42.com/Calculators/debt-reduction-calculator.html (downloadable Excel file) to evaluate the interest cost of different payment options.

I meant for my question to be more complicated than that.  I understand how to calculate the interest cost of different payment options.  I'm unsure how PMI on the rental property plays into the best strategy.  I'm also interested in feedback regarding investing vs. accelerated payoffs.

[dandarc]

Think of the PMI as additional interest on the amount you have left before it goes away.  Your case:

$100 / month * 12 = $1200 / year PMI
112K - 93K = $19,000

Effective additional interest today = $1200/$19000 = 6.3%

Add the 3.75% you're paying, and this $19,000 portion of the debt is effectively at 10% or so today.  And it gets worse as you get closer to the magic PMI goes away number.

[dandarc]

I should add, 10% absent tax considerations.

[RockYourSocksOff]

Think of the PMI as additional interest on the amount you have left before it goes away.  Your case:

$100 / month * 12 = $1200 / year PMI
112K - 93K = $19,000

Effective additional interest today = $1200/$19000 = 6.3%

Add the 3.75% you're paying, and this $19,000 portion of the debt is effectively at 9.9% or so today.  And it gets worse as you get closer to the magic PMI goes away number.

I was hoping someone would say that because that's what I thought.  Though wouldn't my effective additional interest be $1,200/$112,000 at 1.07% for a total effective interest of about 4.8%?  Initially I thought it made sense to throw money at this mortgage but that effective interest rate as I calculate it is still less than that of my business debt.

[MDM]

I'm also interested in feedback regarding investing vs. accelerated payoffs.

As dandarc has covered the PMI, the answer to this one is easy: once you assume an investment return, put your money toward whichever rate is higher: the investment return or the loan interest.

The hard part is knowing what your investment return will be.  But once you pick that number, the answer to your question is easy.

[dandarc]

No.  You get to stop paying that $100 / month when you get down to 93K.  What if instead of 1 loan, you had 2 loans:

19K on credit card at 10%
93K mortgage at 3.75% with no PMI

You might say "I've got 2 loans, 112K total, and between them, the interest is 4.8%".  But if your goal is to prioritize for payoff, that would be a clearly incomplete way to look at it.

[dandarc]

And it gets worse as you get closer to the magic PMI goes away number.

I'm also not sure this part is fully appreciated.  So why not more numbers.  If you pay regular payments for another year, maybe your principal is now down to 110K (you didn't list a payment, so this is hypothetical). 

Now the computation goes $1200 / $17000 + 3.75% =  10.75%

Another year, another 2K in principal: $1200 / $15000 + 3.75% = 11.75%

Taken to the extreme - what if your balance is $93,010 - you can pay another $10 today, or you can pay $100 in PMI for another month.

Monthly PMI is a pretty shitty deal in general and should be gotten out from under ASAP.

[RockYourSocksOff]

No.  You get to stop paying that $100 / month when you get down to 93K.  What if instead of 1 loan, you had 2 loans:

19K on credit card at 10%
93K mortgage at 3.75% with no PMI

You might say "I've got 2 loans, 112K total, and between them, the interest is 4.8%".  But if your goal is to prioritize for payoff, that would be a clearly incomplete way to look at it.

Thanks!  I really wasn't grasping this until you suggested looking at it as two loans.  I figured out that the principal, interest and PMI payment that goes toward the $19K portion of my loan is $176.52 per month.  I ran a snowball calculator I use (and the one MDM suggested which I like better, Thanks!) and figured out that if I were to add $1500 per month to my payments I can pay off the business debt (excluding truck) and the PMI portion of the mortgage in about 22 months.  Paying down the mortgage first actually saves me about $1060 over that 22 months vs. snowballing the business debt first. 

That's a savings of $48 per month over that 22 months which obviously isn't a ton of money.  What are everyone's thoughts on which debt is worse to have?  Because a bank would look at my business finances separately from my personal does it still make more sense to focus my efforts on the mortgage debt?  At least now I know for sure that it is a cost savings to work on the PMI first.  Is there anything I should be considering that I'm not?

[RockYourSocksOff]

Update:

• I've completely paid off both business loans!!!
• The company truck is next on the list
• I've learned that I could have 90% equity in my rental property and I will still be required to pay PMI until April of 2017

I plan to have the truck paid off by spring.  That's the last vehicle I will ever finance.

Now I'm trying to determine if I should go crazy on paying off my mortgages or go crazy on maximizing tax advantaged retirement contributions.  It looks like this year we will be in the 25% or 28% tax bracket.  I expect to be in the 25% next year but may be able to get into the 15% if we max out all of our retirement accounts.  It seems to me like the guaranteed tax savings might be a better deal than the guaranteed interest savings.  If I stick with my current debt payment plan I can have all debt gone by the middle of 2019 (sooner if business is good) but I will have missed a lot of opportunity to make pre-tax retirement contributions.

My goal is to be financially independent and debt free in 14 years (2029) when I will be 45.  Does anyone have thoughts on the better game plan here; pay off the mortgages or go nuts on retirement contributions?

[Playing with Fire UK]

Well done!!!!!

Choosing investments vs mortgage debt is a personal decision, generally, the maths works out better with investing (IDK about the tax in the US). If you have a really strong desire to be debt free (and this is not just because Dave Ramsey says so), then paying off the mortgage is probably right for you. To me then having more savings than mortgage is the same as being debt free, but I see that this is different for other people.

As you are looking to be FI at 45, think about how much tax advantage you can get in the next 14 years (14*$18k = $252k ?) and how this compares to your FI number. I found that I needed to get all the higher rate tax advantage I could, which meant it needed to start early. Would there be a benefit to putting all the pay that would incur 25% or 28% tax into the retirement account and the rest onto the mortgage?

[RockYourSocksOff]

Well done!!!!!

Choosing investments vs mortgage debt is a personal decision, generally, the maths works out better with investing (IDK about the tax in the US). If you have a really strong desire to be debt free (and this is not just because Dave Ramsey says so), then paying off the mortgage is probably right for you. To me then having more savings than mortgage is the same as being debt free, but I see that this is different for other people.

As you are looking to be FI at 45, think about how much tax advantage you can get in the next 14 years (14*$18k = $252k ?) and how this compares to your FI number. I found that I needed to get all the higher rate tax advantage I could, which meant it needed to start early. Would there be a benefit to putting all the pay that would incur 25% or 28% tax into the retirement account and the rest onto the mortgage?

I think I agree with your statement that having more savings than mortgage is the same as being debt free though I would use the word similar over same.  If it weren't for the tax advantage of contributing to retirement I think I would definitely pay the mortgages off first.  However, we have access to a ton of tax savings if we max out all of our tax advantaged accounts.

• Her 403(b) - $18,000
• Her 457(b) - $18,000
• Her IRA - $5,500
• My Simple IRA - $12,500
• My IRA - $5,500
• HSA - $6,750

That's a total of $66,250 we can stash pre-tax.  If I can do that every year for the rest of my 14 year plan that should be well over a $1,000,000.  It seems like it would be silly to put that money toward mortgages as every year I don't take advantage of the tax savings is a lost opportunity.  I think the plan going forward will be to max out all of these accounts and then throw whatever is left (if any) at the mortgages.  Hopefully I can knock the mortgages out in the next 4-6 years and still max out the tax advantaged accounts.  I sure wish I thought this way when I was 22.

[dandarc]

I sure wish I thought this way when I was 22.

Word.

FWIW, our priorities are:

1.  Her 457
2.  My Solo401K
3.  IRAs (mostly Roth, but we are sure to do as much traditional as we can.)
4.  Mortgage

Basically, the tax-advantaged accounts come first, then the excess goes to the mortgage.  Of course we know this is sub-optimal - replacing 4 with 'taxable investing' would likely be better long-term, but we do it anyway because our house happens to be a relatively small part of our financial world - house will be paid off next year, at which point, we'll save up a bit for some needed renovations, then open the taxable account.

Anyway - good work.  And actually thinking about this stuff is like 80% of the battle.  Not like one of the options being considered is hookers and blow.