Help a Reader: House Payment Options

Here's an email I recently received from a reader:

Here's our background and financial information.

• Married with a toddler and another baby on the way -- live in the metro NYC region. Wife and I are are in our late 20s.

• Have about $30,000 in cash (savings).

• Have about $75,000 in 401(k). I try to max my annual contribution.

• Have about $15K in various divended yielding stocks

• Current salary is $94,000 annual. Bonus between $10K-$25K. All in $104K to $119K. Monthly take home is around $4,600. Job is very stable.

• Wife does not currently work. She may return to work when second one goes to pre-K (this would be in a couple years)

• We own a $450K condo. It's a 1BR + 1Den. It's big enough that we can have family of 4 (tight but doable).

• We put down 10% on the condo in 2007. Loan of $400,500 at 6.25%. Including taxes of $7,226 annually, our monthly payment is $3,086. Plus common charges of $350. So monthly carrying costs of ~$3,400. Doesn't leave a lot leftover given monthly take home pay (wife used to work before we had our first, so things are tighter now)

• Approximately $387K left on the mortage now. My unit was appraised at $385K, meaning I have no equity in the condo.  

• No other debt (we pay off credit cards monthly, following FMF's advice to pay in full and reap rewards!). I do have a student loan of around $20K at 3.25% that is about $130 a month. I can deduct this in my tax return though

• We are gospel believing Christians and tithe generally between 5-10% of our gross income annually

Here's our situation:

I am exploring a refinancing on my unit. Due to the new gov't rules, despite my condo having depreciated (say 20%), I can take advantage of refinancing.  I can probably get a new rate between 5 and 5.25% (current rate is 6.25%). Closing costs of around $3,000 (says my mortgage guy).  I'm probably 95% going ahead with this because it would allow me to save around a few hundred dollars a month.  We plan to stay in our condo for another 2 years, at which point we'll need to move (more space as well as looking at better schooling options).

Here's the kicker --> about to receive an inheritence/gift of approximately $150K (coming from Asia - not sure if this is taxable in US on foreign gifts?).  I'm not sure whether I should use this cash to help pay down my principal (there is no prepayment penalty).  If this were a house and town we'd be staying in for the long-term (ie, raise our kids through college etc) -- then it's a no brainer to pay down the mortgage and be debt free faster.  However, since we are planning to move in 2 years or so (possibly to West Cost or a more suburban town in tri-state NY area), I'm not sure if there's value in paying down principal, only to sell our place and it's possible that with a double-dip recession -- prices could be depressed.  Another option is maybe just investing the money?  Or do I do some type of paydown + new refinancing?

What is your advice for him?

Comments

[JimL]

If you are moving in the next 2 years, do you really see the need to refinance? Doesn't seem to be much of an ROI. Pay off the student loans and save the rest.

[jon]

How are you able to refi that condo for only $3000? You have to repay the mortgage recording tax on the new mortgage, even if it's a new mortgage to the original owner. That's 2.05% in New York City. So that's $8K if you refi the full $386 + bank costs. Perhaps $3K is the bank costs exclusive of taxes? I would question that $3K figure.

[dogatemyfinances]

I agree that the refi number is very fishy.

That inheritance will be a little less than your current net worth, right? Why on earth would you pay down a condo you are leaving? I think you need a lot more cash with a baby and those kind of monthly expenses. I think you could also use more in retirement, if you can still add on with IRAs or other vehicles.

When you make as much money as you do, and you are worried about a few hundred a month, you are called house-poor.

[Nick]

It sounds like you live next door to me (taxes, home value, condo fees and school issues...). I assume you're on the PATH in NJ and get really annoyed at all the people lined up on Washington St. all day near the CVS, to not get too specific?

I know a GREAT mortgage broker if you want to speak with someone else about refi options ($3,000 does seem low). Four people I know (two relatives, one friend and I) have all reached out to him about refinancing or buying a house. He spent a lot of time with us, looked at documents asked us questions and told EACH of us NOT to either refinance or buy. He said either it wasn't worth the closing costs or to buy based on our situation. So I don't know of anyone who has ever used him, but 4 have tried. His name is Kit Crowne at Right Trac Financial Group. If not him, definitely talk to someone in addition to your person just to be sure (I am not affiliated with Kit or get any $$ for referring him, fyi).

Because of your short timeframe it probably doesn't make sense to spend money to refinance. But you may want to reach out to your existing lender. One of the Obama plans might fit with you, so you may be eligible for a loan modification.

Also, here's a decent place to start for your tax question - http://www.irs.gov/businesses/article/0,,id=200722,00.html

Good luck and congratulations on the new addition!

[Money Reasons]

I'm not sure it would be worth the trouble if you are moving in 2 years... I think I would put the $150,000 in some type of high yields savings and just wait it out.

My path might not be the optimal from a saving perspective, but it would be low risk and easy.

[Everyday Tips]

I wouldn't refi or pay down the condo if you are leaving in two years. You need as much cash as possible since you have so little at the end of every month after paying the mortgage. I would invest some of the cash and keep the rest in a nice, safe, FDIC insured place. (Might consider paying down that student loan too.)

However, the last thing I would do is pay down the condo.

[Carol]

Keep the student loan, and squirrel away that inheritance for your next home. You're in a good place financially. I would also start a college fund for your toddler.

[Catherine]

The refi and inheritance are unrelated and should stay that way.

There is no reason to continue to pay 6.25% if it can be lowered. Staying for 2 more years is not the same thing as selling in 2 years. When you have to move, and have a tenant instead of a buyer, your options for refinancing are extremely limited.

With the inheritance, don't prepay. Maximize the non-working spouse's retirement accounts first, then college savings accounts for the kids. What ever is left from that will be needed for that house you might buy in 2 years. Invest it accordingly.

[fka CPA Abroad]

The inheritance/gift is non-taxable to you.

I would go the high yield savings account route with it if you have any intention of using it for a down payment when moving. You mention the double dip with house prices, but if that happens the market will probably struggle as well. Not sure the upside is worth the possible downside.

[Keith]

Pay off the student loan. You won't miss it. I would bank the rest.

[KMI]

I'd chime in with the rest of the posts - don't pay down the mortgage. Moving in a couple years means that you'd probably get more value out of having the spare cash to pay for closing costs, home repairs, and so on for the new place. With only one income, two kids, and a tight budget, you are probably much safer bumping up your emergency fund substantially. Even the stablest jobs can catch you by surprise with cost-cutting measures taken by a company. You will also want to hold on to a fair amount of the gift/inheritance until you know exactly what it will do to your taxes. It might be worth taking to a tax accountant who is familiar with foreign gifts to make sure everything is planned for and handled appropriately.

You didn't mention a ROTH IRA, or a spousal IRA. I would recommend looking into those as a good alternative for places to put a portion of the $150K coming in. I believe a nonworking spouse can make a deductible IRA contribution of up to $5,000 for 2010, and setting up something for her now where you can contribute a portion each year would give some extra time for it to grow. It does mean putting a chunk of money aside with the intent to make the contribution each year in the future while she stays home, but that might be worth it.

A ROTH IRA contribution is not deductible, and again the limit is $5000 - but by making it every year, you can get a nice nest egg. As a side benefit, since you can always withdraw the money you contributed, this can be an alternate place to stash some emergency money. If you never need it, you have it invested for your retirement and can withdraw it tax free then. If you do need it, it's not locked up in a 401K or traditional IRA where it can be harder to get at in an emergency.

Re the refi - If total out of pocket for you is only $3000 (inluding any points paid, banking fees, mortgage fees, appraisals, new taxes paid, and so on), the amount of the loan does not go back up, and it saves you a few hundred dollars each month then it makes sense. It will take a full year at a savings of $250/month just to break even with the costs, but after that it might be worth it. Just bear in mind that a portion of the savings you get is not from a reduced interest, but rather from stretching out your remaining loan balance over 30 years again. This means that your equity will probably build more slowly than with the existing loan.

[Old Limey]

If you are planning a move in 2 years it would be stupid to refinance now.

You probably have never heard of the "Hindenburg Omen" but it is a rare stockmarket signal that was confirmed yesterday. It warns of a financial hurricane ahead. http://online.wsj.com/article/SB10001424052748703321004575427791421316112.html?mod=rss_markets_main
You should put your 401K into the safest option that you have and be prepared to ride out another bad period on the way.
With your income at your age you are obviously very talented in your field. I would only move to the West Coast if you have a job to go to. I live in Silicon Valley and jobs like the one you already have are exceedingly hard to get unless you are sought after. Now is the time to circle the wagons, hunker down, and ride out whatever difficulties the next 12 months may bring.

[Ryan]

Without knowing the specifics of your situation, but going on general guidelines for financial success, it seems like your condo is way too much for you to handle comfortably. Paying 74% of your take-home to support your condo means that you will never be able to get ahead financially.

It seems to me like you need to reign in your idea of what level of house is appropriate and get something more in line with your income. It may not sound appealing but it sounds like you need to sell that place and move into something that costs half of what you're paying now, even if it means a long commute or a different lifestyle.

[Troy]

I appreciate the post, but the most important thing written was by Old Limey just above.

And I mean the most important thing written in the past 6 months.

Pay attention to him. Pay attention to what he says. I fully agree.

If you have money in the market, you have been warned. The 10 year yield is in PANIC mode. The pros are preparing, and have been for several weeks.

[Budgeting in the Fun Stuff]

Only refinance if it will indeed save you money. Personally I'd save the $150,000 and use it to fund 2 Roth IRA's like KMI suggested. That way you'd be adding to your retirement fund and have the cash on hand for any extra baby expenses and for the downpayment on your new place in 2 years (in case your condo doesn't sell or it's still not a good time to sell). Good luck!

[jim]

If others are right and the $3k closing is a low estimate then I wouldn't refinance. If that refinance is actually going to only cost $3000 then it would probably be worth doing, but only barely. Cutting 1% off your interest on a $387k loan is $3870 a year. So it would pay for itself in about 1 year. But you' only plan to be there 2 years. You really only stand to save maybe ~$2k after taxes with that refinance in 2 years.

Don't pay down the mortgage with your inheritance. You're moving in 2 years. Sit on your cash in the meantime. When you move you can then pay extra into the loan to make up for the lack of equity. Till then you've got no reason to give the bank extra money.

[D]

@Troy and Old Limey

Where do you suggest we put our investments then? Bonds, MM, ???

[jim]

That article on the "Hindenburg Omen" says that it has happened "many" times that did not proceed a crash and they say that only 25% of the time did a crash follow the omen. 25% accuracy is pretty bad. 25% gets you an F.

[Rob Ward]

As others have mentioned keep the cash on hand as your emergency fund and to fund retirement and other savings or college for the kids. Definitely don't use it to pay down the mortgage since you are planning to move within two years.

For the first six months of getting the money I would just bank it in a savings account (or two) and let it sit. Get used to seeing that much money in your account before you start moving it around different places.

[jimmy]

DON'T TOUCH THAT MORTGAGE.
1) Your condo value can still drop further. When you sell, you may have to pay to make up the difference between your mortgage balance and the sales price, including any selling expenses. Why pay these ahead of time and lose equity, too?
2) Why refinance a mortgage only to move in 2 years? You will not have enough time to recoup your refinancing expenses.
3) Make sure you have more in your emergency fund
4) Don't pay off the student loan just yet. Inflation is just around the corner.
5) Put the rest of your cash in a SmartyPig account to get 2% interest.
6) Look into putting some cash in peer-to-peer lending. This is somewhat speculative. Investigate it thoroughly.

[Catherine]

The government sponsored program to let a person with zero equity refinance to a lower rate does not last forever. If the upfront costs are recouped within one year, this is a no-brainer. Full speed ahead with a refinance, right now, while you can.

[Old Limey]

@D
I will give you my portfolio allocation but bear in mind that we are in our mid seventies, retired, wealthy, have income from pensions and SS checks, and our portfolio has been essentially almost the same since October 2008. It changes primarily when individual muni bonds or CDs mature and I have to reinvest the proceeds. The income from them is reinvested as it arrives. With three of my high yielding CDs each bank failed but I didn't lose a cent thanks to FDR and the FDIC insurance that was passed in 1933 during the great depression when 40% of all banks failed.

44% -- Individual municipal bonds with maturities laddered from 2010 to 2022 - Average yield 4.964% tax free.
38% -- FDIC insured CDs with maturities laddered out from 2010 to 2019 - Average yield 4.56% tax deferred.
18% -- Two municipal bond funds yielding 4.5% & 4.2% tax exempt. Total return last 12 months including capital gains is 16.8% and 14.0% because of the rise in municipal bond prices.

The two municipal bond funds are held in our IRAs, this is unusual because IRAs are tax deferred, it's just that the municipal bond funds are currently higher in my rankings than taxable bond funds that I have used in the past. There was even a period earlier when tax exempt money market yields were higher than taxable money market yields which is also very unusual.

[JimL]

Old Limey,

Would love to see returns like that for new cash deposits. I have another 100K in cash coming in over the next 6 months that I want to park. Sorry to get away somewhat from the subject, but it is also appropriate for the original poster as they also probably want to know where to put the cash.

[brooklyn money]

This is a tough one, I feel like you can tell by the variety of responses. I would never feel comfortable spending that much of my monthly nut on housing. I would sell and rent. You can probably rent something for less than you are paying in mortgage. Get out now while you can, before the value of the condo goes down even further. Especially if you plan on moving in 2 years anyway. Why wait to sell then? Also, agree with Katherine. Pay off the student loan.

[Holly]

I, too, would sell and try to find a lower monthly rent.

If you decide to stay for only 2 or 3 years, I don't agree w/the advice to refinance... only 3 exceptions might be:

1). Do a refinance to a VERY low 5 or 7-yr. ARM w/ING (or other bank) that comes w/the absolute lowest possible closing costs. Remember, too, that refinancing resets your payment schedule back to the beginning, so almost all of your monthly payments will again go toward interest!

2). Ask you current lender or other bank to do a mortgage modification (as suggested by others).

Definitely agree w/the other comments that holding the inheritance/gift in a safe, high-yield savings account and then re-positioning the assets into growth funds after a period of time (say 2 years).

Do not rush to pay back the student loan. Cash is king. Good luck with your decision.

[Strick]

So housing + tithe + student loan = monthly take home. Ouch.

Why not start looking to move now?

[Harrken]

1. I would take 5-10% of the inheritance and celebrate, i.e take a nice vacation or something.
2. With the rest I would pay off the student loan and any consumer debt.
3. Then I would look at selling the condo now and using the cash as a down payment on something larger and start building equity. I think you are going to find the condo really small especially when the new child arrives. With housing prices and mortgage rates as low as they currently are it is a buyers market.

[Karl Hungus]

Heres my advice.

1) Wait until the inheritance comes in. Dont make decisions until then because it could take longer then you think and never want to be in a situation where you have to do something financially. It is stressful.

2) Sell the condo now (once you get the inheritance) and look for a bigger place. Look very very hard to find the house/townhouse/condo that will best suit you future needs. When you have the inheritance you can take your time selling your condo and buying a new place without stressing about realtor fees, mortgage buy out and closing costs. Talk to someone you trust about mortgages. There are little things you can do that can shave lots of years off of your amortization. Pay bi-weekly instead of monthly. You will make a couple extra payments per year without missing the money and the payments go straight to principal. If you are risk averse do a variable mortgage - 99% of the time it is a better rate. Then make the payments as if they were
fixed. For example, if, with the variable rate your payment is $1350 per week, tell the mortgage company to make them $1500. Nothing has changed but you could shave like 10/15 years off your amortization.

3) Once all of this is settled, pay off the student loan. Unless you are savy investors and can get 7%+ from investing. This is not recommended unless you know what you are doing.

[DKG]

@ D

Just want to applaude your effort in keeping God as a part of your priority even during a stressful time like this.

Consider offloading the current property and search for a more permenant and suitable one for u & ur family to grow for the following reasons:

1. STRESS - $3,400/mo on housing along for ur income level & other financial obligations, such as ur family & a growing child is high stress, and

2. TIME & AFFORDABILITY - In a declining housing market like this, unless u can afford to hold on to ur current as an investment until the market comes back up, u might want to seriously considering taking the loss right now and take advantage of the same low housing market to get a more suitable and permenant place because the market might not come back within the next few years with the current high unemplyment rates and unstable economy, and

3. NEED - U need a bigger place soon with ur growing family and chances r that u won't be able to rent ur current for the $3,400/mo expenditure to break even, so u can't afford to keep it in the long run to make it an investing, so don't waste ur time on current. Offload while u can to reduce further loss, and

4. REFI - might not be cost effective if u'r offloading it in 2 years. Again, as mentioned above, if u r to offload in 2 years, consider NOW. Refi's not going to make enough impact on $3,400, and

5. CASH FLOW - $3,400/mo is not going to help w/ cash flow. U might want to considering maint 12 mos of absolute monthly expenditure as reserve in an economy like this. (6 mos for a good economy, which we don't have.) U do not wanna get caught off guard duing a time like this regardless any type of job security u might think u have, and

6. TAX CONSIDERATION & SAVINGS - $150K, is this pre-tax or after tax? Sorry, I'm not tax savvy, but u should find out just to be sure for ur planning purpose. U don't want to budget something that belongs to Uncle Sam. I will not rush right into savings beacuse:

6a. If u decide to offload ur current property that has no equity as recommended and seriously considering a more permenant and suitable place, I would recommend u use a portion of that $150K to put down 20% because it saves u 1) PMI (Private Mortgage Insurance) and 2) MIP (Mortgage insurance premium). The 2 mortgage insurance related exps mentioned above applies when u have less than 20% in equity or more than 80% in LTV (Loan to Value), and

6b. It's some what good to have an affordable mortgage and property tax because it allows u to take advange on below the line deduction (or itemized deduction). This way ur tithes offering can be deducted as well.

6c. U want to make sure u do ur tax planning right. U want to make sure u take advantage of above the line adjustments, such as qualified IRA contribution, FSA (Flexible Spending Account, pre-tax contribution), HSA (Health Saving Account, pre-tax contribution) and student loan interst, etc. (Please be familirize w/ ur tax or seek trustworthy tax expert on the forementioned recommendation.

6d. Don't forget about any tax credit. Btw is there a $6,500 tax credit for repeat home buyer going on right now? Please do a little research on the tax recommendation I made. (*disclaimer* I'm not tax savvy).

6e. W/ all that said, if u still have extra from the $150K, invest conservatively at the current market. U should not settle for 1% CD, esp there areonline saving, money market account (MMA) that are more liquid yields about 1% too from... (ING Direct, CitiBank... to be checked. I have mine in Citi, but I haven't got time to check lately). Be current on market update. Diversify. W/ possible "Hindenburg Omen", speculate a little. Don't rush into the market yet because there's a possibility of market correction or selloff in a month or 2. Government bonds might be more stable and less risky too at this point. Municiple bonds' tax free on earnings. Series EE, educational fund, free of tax with condition for ur toddler as someone might have already mentioned. Invest wisely. Make sure u have enough to provide for ur family first. If u have extras.. invest. As a late 20s, u can invest.

I think nuf said from me. Hope some of what I mentioned serves an useful purpose. God bless u and ur family.

From..another late 20s.. Droid

For all the experts in the readers, please add, comment or correct. Thank you.

[Funny about Money]

I wouldn't put money into property I didn't intend to keep for the long term.

First, even if you can get a refi for three grand (which sounds a little dubious in NY, though that's what we paid in AZ), it's not worth tying up your capital for something you're going to dump in two years.

Second, there's no guarantee real estate will begin to appreciate anytime soon. Worse, there's some possibility it will continue to slide. Even though you have no equity in the place, that's a lot better than being upside down. Why risk the inheritance by throwing even more money into real estate?

The student loan is deductible. Unless you need that $130/month for groceries or other real necessities, you'd probably be better off to keep the cash in something relatively safe, at least until you're ready to move. If you want to put it into real estate, put it in a property that you're likely to stay in for at least 15 years.

If I were you, I'd invest the money in a high-yield FDIC-insured savings account and then try to sell the condo (raising two kids in a one-bedroom apartment sounds pretty darned awful! what does the person who has to stay home with them all day long think about this situation?). While it sits on the market (which it will), I'd look really hard at school districts, living conditions, and viability of neighborhoods and then look for a short sale or repo that's big enough to accommodate the family you plan. I also would compare the cost of buying vs. the cost of renting. When you're buying a house with no equity through a mortgage, basically all you're doing is renting it from the bank.

With any luck, you'll break even on the sale of the condo. You may have to bring a couple thousand dollars to the table to get rid of it, but with $70,000 or so in the bank (depending on taxes), you can afford it.

If you can get a smokin' deal on a bigger place AND you know you will stay put for upwards of a decade, use the money, whatever's left of it after taxes, to engineer the smallest possible mortgage. You should eventually come out even or ahead.

Alternatively, given the uncertain state of the economy, consider whether renting would get you into something better for the same or less expense, allowing you to keep the inheritance in savings. Then you wouldn't be shackled with a mortgage. No job is forever these days...

[Old Limey]

@Funny about Money
Your advice is sound but .............
I checked Fidelity Investment's offerings of FDIC insured CDs. These were the Top 3 bank CDs for yield.

3.1% -- Matures in 2015 -- Not Call Protected
2.9% -- Matures in 2020 -- Not Call Protected
2.8% -- Matures in 2020 -- Call Protected

I wouldn't exactly call these high-yield FDIC insured investments. I would suggest that he puts the money into a good higher yielding bond mutual fund and watches it closely, the way I watch mine. At least the money isn't locked up and is available at any time. There are a good many bond funds that have also gained in price YTD in addition to the monthly interest.

[Mark]

It is amazing how people rely on inheritances to fund their consumption. Have you ever heard of work (your own?). Don't live beyond your means. You cannot afford your current lifestyle!

[Tony]

I don't believe in the "Hinderburg Omen" or any other omen when it comes to the Stock Market. We are in a very slow recovery and that fact is already factored in the market, that is why we peaked back in April. People just need to understand that the times of 10% annual returns in the market are over, the new normal will look more like 4%-6%. Looking at this new reality I would put the condo in the market today, who knows how long it will take you to sell it. You might be able to sell it without much of a loss.

If you wait two more years to sell you might be looking at a Short Sale, or even a Strategic Foreclosure because eventhough you might have the cash to pay the difference it might not be worth doing it.

After you sell the condo find a place you can rent for the next couple of years until you move to the West Coast (where I would also rent at first).

Take the 150K inheritance and assemble a Bond Ladder with medium term maturities (3-7 years). A good mix of CDs, Municipal, Treasury and Investment Grade Corporates could yield 5-6% with relative safety. Open ROTH IRAs for you and your wife (for your age, 75K in retirement is not bad but it's not great either).

Don't pay the student loan. 3.25% is a very low rate (with tax deductions it might be about 2.6% effective rate).

[BPErickson]

Mark, there is no indication here that they haven't "heard of work." Please be kind - these folks bought too much house, that doesn't make them lazy.

I agree with the others commenting here - sell that condo ASAP, take the loss, and find a place you can better afford. Even if it means renting a couple years, that would be preferable.