Author Topic: Noob Looking for Advice  (Read 4516 times)

jpmcgee

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Noob Looking for Advice
« on: June 07, 2013, 10:38:53 AM »
I know I must be the millionth person to post a thread like this, but hopefully some of you enjoy working on people's financial puzzles.  So here's our situation:

Unmarried but long-term partner, I'm 32 she's 36.  She has a high income (130K), and I'm trying to get a business off the ground, so income is incredibly one-sided right now.  She has a 401K (no employer matching) that probably only has 10K in it, a Roth IRA with 11K, and High Interest Savings at 11K.  I have nothing yet. 

- Combined student loan debt - appx. 290K (woohoo!)
- Mortgage - 289K @ 3.5%
- Consumer debt - 0
- Vehicle - Owned outright
- We live in the city, so no commute (bike and/or public transportation)
- We're in the process of cutting costs as low as possible, but given the mortgage and student loan debt, it keeps expenses high enough that saving in amounts advocated by MMM is not possible.  Those two expenses alone consume over half of net income, and I'm barely paying on my portion right now since I'm on income-based repayment.  So I'm currently just piling up even more interest.  Oy.

So I have a few questions in terms of priorities -- what should we dumping most of our money into at this point?  I assume student loans since they have the highest interest rates, but there's one issue with the house I wonder about: 

On top of the mortgage, we're on the hook for PMI at a whopping $298 a month (yeah yeah, I know - if you're tempted to lecture you can skip that part). We have an opportunity to add value to the house, so I'm wondering if in the short term we should put money into the house (both improvements and curtailing the principal) and try to find a refi where we can get rid of the PMI?  We probably can't get to an 80% LTV with that alone right away, so this could theoretically happen sooner with an 80/10/10.  Would this even be worth it to avoid the $298 PMI?  I suppose this depends entirely on the rates we could get.  Or maybe it makes more sense to just get the house to 80% ASAP via curtailment and then refi then?

There's also an external space that we could theoretically turn into a micro apartment (240 sf) and rent for maybe 400-500/mo., but that would require dumping money into.  Obviously we could recover it in a few years, but I'm not sure if something like that would help us with a refi deal.

Aside from that, I assume she should be putting her money into a Traditional rather than a Roth, correct?  Her financial advisor advised her to put into Roth, but that makes no sense to me at her marginal rate.  I realize now that I think he assumes her income will rise indefinitely and that she aspires to live a richie-rich lifestyle in retirement.  Not our desire.  Or, perhaps aside from accruing a safety net, should she not even put money away at this point and instead dump everything into paying down debt?

Just trying to put together a smart game plan and I'm new to this.  Any advice would be appreciated.  Thanks y'all. 

Rebecca Stapler

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Re: Noob Looking for Advice
« Reply #1 on: June 07, 2013, 11:17:32 AM »
I'm confused, because you're wondering where to put your money yet you're only paying interest on your SLs? Where is the theoretical extra money going to come from?

That said, I would hold off on doing upgrades as a way to boost your equity, because at best about 70% of the cost of the upgrades will boost your equity. Whereas 100% of each dollar put towards your principal will go towards your equity. You get more bang for your buck putting the money straight towards principal.

As for where to put the theoretical extra money, it depends ...
How much $$ do you need to pay off of your mortgage to get rid of PMI?
How much $$ do you need to pay off each SL, and what is the interest on them?
How much is the theoretical extra $$?

jpmcgee

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Re: Noob Looking for Advice
« Reply #2 on: June 07, 2013, 12:03:43 PM »
The student loan debt is 40/60 hers and mine, respectively.  So that comment about income-based was about mine only. Basically, my situation is horrible and that's something I alone will deal with - I'm not going to saddle her with that. This is more a question about where to direct her money.  Her SL debt is 112K with 85% of it a mix of 6.55 and 7.55% rates. 

The extra money is roughly 2000/mo. But my income is so erratic that at times I can put chunks in somewhere, but it's no set amount.  So that's part of the theoretical extra -- a few hundred here, a thousand there, etc.  So I guess it's a 2-part system - where best to put the predictable 2000/mo., and then what should we do with any extra I bring in.  Another part is the amount she has saved up - wondering if some of that would be better used paying down debt vs. invested vs. currently earning piddly interest in savings.

I guess we should just grin and bear the PMI -- we're talking 40K to get it to 80 LTV, so I hear you on the 100% equity impact on principal curtailment.

velocistar237

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Re: Noob Looking for Advice
« Reply #3 on: June 07, 2013, 12:21:58 PM »
Pay down and get rid of PMI. The effective interest rate on the PMI portion of your loan is north of 10%.

http://www.westga.edu/~bquest/1997/costof.html

If her student loans are a mix of rates, when she does pay them off, be sure to make extra payments toward the highest-rate subloans. For a while, our loans were bundled as a mix of rates, but they became unbundled when the loan servicer changed, and we were able to wipe out our high-interest subloans independently. I'm sure we could have done it beforehand with a check in the mail.

Rebecca Stapler

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Re: Noob Looking for Advice
« Reply #4 on: June 07, 2013, 12:44:18 PM »
Pay down and get rid of PMI. The effective interest rate on the PMI portion of your loan is north of 10%.

http://www.westga.edu/~bquest/1997/costof.html

If her student loans are a mix of rates, when she does pay them off, be sure to make extra payments toward the highest-rate subloans. For a while, our loans were bundled as a mix of rates, but they became unbundled when the loan servicer changed, and we were able to wipe out our high-interest subloans independently. I'm sure we could have done it beforehand with a check in the mail.

I am going to disagree on this one. I would focus on the lowest balance first, so she can get rid of a monthly payment. But that's just me and my inclination to inch toward freedom through having fewer monthly payments, and when they're gone, using that money towards the debt payoff without making lifestyle changes. This is the difference by getting the rational most bang for your buck versus the emotional lift of having fewer minimum fixed payments. It's a personal decision, IMO.

If her lowest balance SL is over $40k, then I agree with the first part of velocistar's comment -- go for the PMI. She wouldn't get rid of a monthly SL payment before she would get rid of the PMI. But if it's less than $40k, I would go for the lowest-hanging fruit. Again, I think there's an emotional factor as well as the rational factor.

Rebecca Stapler

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Re: Noob Looking for Advice
« Reply #5 on: June 07, 2013, 12:49:40 PM »
Oh, as to the amount saved up -- I wouldn't move it if I were her (unless she wants to put $5500 of that liquid savings into a Roth as her 2013 contribution, since she can always remove the principal if she has a dire emergency). But she should, at the very least, max out her Roth every year -- especially because she can do that in 3 months.

I hope another Mustachian can weigh in on why a Roth is a better idea even with her high salary ... I understand it to be something about how more money is working and available later if it's in a Roth, because the taxes have already been paid. But I can't articulate the concept very well.

velocistar237

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Re: Noob Looking for Advice
« Reply #6 on: June 07, 2013, 01:23:36 PM »
I am going to disagree on this one. I would focus on the lowest balance first, so she can get rid of a monthly payment.

Then you are disagreeing with MMM (and "Math", according to MMM).

Quote from: Mr. Money Mustache
Because we’re using Math, for example, I’m not going to tell you to pay off your smallest debts first as with the Ramsey “debt snowball”. I’m going to tell you to pay off your highest interest debts first.

I could see there maybe possibly being slightly more stability in a different strategy, but I bet the effect is too small to be worth it. If I myself were to pay off the smallest debt first, I would be discouraged because I would know that it would take more money to repay my debts.

I hope another Mustachian can weigh in on why a Roth is a better idea even with her high salary ... I understand it to be something about how more money is working and available later if it's in a Roth, because the taxes have already been paid. But I can't articulate the concept very well.

It's usually not a better idea. She should use a Traditional, because her expected income tax rate at time of withdrawal will probably be lower than her marginal income tax now, and that's the only difference between Traditional and Roth as far as returns go (there are some differences in inheritance, I believe). Only if you plan to have a higher income tax rate in retirement should you use a Roth, and even then, you can get around it by giving money away.

You can find more on the Traditional vs. Roth discussion in other forum posts.

jpmcgee

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Re: Noob Looking for Advice
« Reply #7 on: June 07, 2013, 01:25:37 PM »
Thanks for the responses, I appreciate it.

I hear you on the emotional aspect, but her student loans are a single collection of a dozen separate loans.  They're currently scheduled on a 10-year standard repayment plan, which is just one lump monthly payment.  We'll have to look into whether the servicer will allow curtailment of specific individual loans that have higher balances and higher interest rates.  So, yes, individually, every single one of her student loans are less than 40K.  But I believe Velocistar was saying that because the PMI's effective interest rate is more than 10%, it makes sense to get rid of that first since it's higher than any of the student loan interest rates.  Not sure how to balance those two.

Re: the IRAs, I read through a few threads on the topic here in the forum and, I could be wrong, but the consensus seemed to be that if you expect your tax rate to be higher in the future when you're withdrawing money, then a Roth makes more sense.  But if your tax rate is higher now than it will be in the future, you should put money into a traditional.  For those who plan to live frugally in retirement (a la MMM), then the future tax rate of income withdrawn from a traditional will almost surely be lower than taxing yourself at the highest marginal rate now by contributing to a Roth.  This also doesn't take into account the tax differences of subtracting traditional IRA contributions to reduce tax liability now.   


jpmcgee

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Re: Noob Looking for Advice
« Reply #8 on: June 07, 2013, 01:34:52 PM »
Ha, thanks velocistar - sounds like I'm on the right track on the IRA situation.

And thanks for the links and info. 

Rebecca Stapler

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Re: Noob Looking for Advice
« Reply #9 on: June 07, 2013, 01:43:09 PM »
I am going to disagree on this one. I would focus on the lowest balance first, so she can get rid of a monthly payment.

Then you are disagreeing with MMM (and "Math", according to MMM).

Quote from: Mr. Money Mustache
Because we’re using Math, for example, I’m not going to tell you to pay off your smallest debts first as with the Ramsey “debt snowball”. I’m going to tell you to pay off your highest interest debts first.

I could see there maybe possibly being slightly more stability in a different strategy, but I bet the effect is too small to be worth it. If I myself were to pay off the smallest debt first, I would be discouraged because I would know that it would take more money to repay my debts.


Yes, that's what I meant by the rational v. emotional difference. Yes, I'm disagreeing with math. In favor of the emotional aspect of getting rid of a payment.

It looks like your partner doesn't need to make that decision though -- if her balances wouldn't drop by paying off a SL, then PMI is both the lowest amount to pay off and highest interest, so she would get the mathematical and emotional benefits by paying off the mortgage first. In that case, I agree with velocistar. It would be