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« FMF March Money Madness, Round 1, Posts 21-24 | Main | FMF March Money Madness, Round 1, Posts 25-28 »

February 21, 2013

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I will probably be the only person who says this, but you are probably losing money with the Roth accounts.

The probability is that you'll be in a lower tax bracket in the future.

But even if you are in the same tax bracket, you're still losing money. You're effective tax rate is your highest marginal tax rate for every dollar you put into the Roth account (28 based on the income figures above), as opposed to 0% for the traditional. Which means that you are adding less dollars, thus you have slower growth over the next 30 odd years.

When you're pulling money out of a traditional account, your highest marginal rate may be 25 or 28%, but what's your effective tax on the money? A lot less than that, maybe around 20%.

Of course if you strongly believe that tax rates will go up, then Roths make sense. But I remain unconvinced that they are a good choice for most people.

To get to the targeted $1500/month for expected costs with a child, you will have to eliminate all student loans and eliminate the PMI. Even with that, you will still need to cut back in a couple areas as the items above will only get you to $1185. The first suggestions would probably be eliminating the cleaning services and home improvements. With a baby, I would also suggest that you reconsider the emergency savings and bump it up even a bit more beyond your plans. You would be surprised at the unexpected expenses.

I know that you are concerned about lifestyle changes, but I would suggest trying to save every dime you can to pay off the student loans and eliminating the PMI, as it will otherwise take you some time to do it.

We hedge with a combination approach, but our percentages are swapped from yours. (In 2013 we plan to max out 2 traditional 401Ks, and put the max toward 2 Roth IRAs.) Basically it seems as though you are living well under your current salaries, so why would that change in retirement? Roths make the most sense for people who are planning on spending in the same (or higher) tax brackets in the future, and you're already in quite a high marginal tax bracket now.

Good Job thus far. I will advice you either stop contributing to your retirement account and attack those student loans or cut back on your expenses for a while. Something have to give. What are you doing with your bonus and tax returns? I have modified your expenses as shown below with my advice in red. Overall , you can find additional $900-$1000 if you want. With that you can knock off your wife’s student loan in 2 months and yours in 2 years or less with your current payments ($650 and $250). The key is to suffer for a short while and reap the benefits latter. You also need a bigger emergency fund. Zig Ziglar said it best, “Expect the best, Prepare for the worst and Capitalize on what comes”. And when your baby comes, you will need all the cash flow you can get. Start now because you will also need to start 529 for the little one.
• $3100 – Mortgage
• $900 – Student Loans ($650 me, $250 wife)
• $700 – Food. This varies but we are usually around $100-$150 per visit to local stores. Buy a mix of organic and non-organic food.
• $400 – Average monthly home improvement items. We expect this number to decrease as we become more settled in our home, but we went from a small 1 BR apartment to our current home, so we had nothing to start with. $100 max. All about what’s priority and you don’t have to do all the improvement at once. Pace yourself and do them slowly.
• $300 – After tax monthly amount for commuter rail passes for wife and I.
• $300 – Clothing (on average, some months more, some months MUCH less). $50. You can buy all the clothers you want latter. Plus the clothes are not earning you 3.75% interest are they?
• $300 – CVS/Target/etc. trips $50. Are these not part of grocery bill? We spend less than $800 on grocery and that is a family of 4.
• $250 – Monthly cable/phone/internet/tablet data/my cell phone. Wife’s cell phone covered by work.
• $250 – Gas/Electric
• $200 – Gas/tolls/general repairs on our one car (2002 Honda Civic)
• $180 – Cleaning lady 2x monthly. $0. Clean yourself.
• $100 – Car Insurance
• $67 - Gym Membership
• $50 – Wife haircuts
• $20 - Monthly Subscriptions – Spotify (Me) and Birchbox (wife)

Your income is great, your retirement contributions and assets are great too, but quick analysis says you are house poor and liquid savings poor. It's good that you have changed your saving habits and that your salary has bumped considerably recently, but if you are stuck and need advice then you probably don't see the flexibilities that are out there for you to make room for future needs with baby, replacement car, student loan issue, PMI, low e-fund, etc.

With your first request for feedback, I would say that you should pay extra on your home down to 20% equity. The PMI you pay is the insurance to cover your lender and not you, so with that view PMI is wasted cash flow every month.

You didn't say how much you currently have in your car fund or your home improvement fund? You also didn't say what kind of home improvements you need/want to do? I'd delay all the "wants" home improvements and use proceeds to speed up your targeted savings rate. Then pay down the mortgage and rid the PMI.

Your student loans interest rate are low so just pay the minimum and keep padding your liquid savings.

You can reduce all your discretionary spending, CVS, Target, cleaning lady, etc. and haggle with utilities from time to time to get the lowest rates possible. Is gas/electric rates high in your area or can your home be better insulated?

The $250 spending cash each will probably have to change when you have a baby, but that may be a choice you make yourself as did I. Having a baby tends to change one's priorities in life and you may find yourself wanting to use this cash on your baby rather than on yourself.

You need to add some expenses to your list....life insurance. Get at least a 20 year level term, add supplemental through work until you feel your net worth is high enough that your term life does not need supplementing anymore. A will and a living revocable trust is also highly recommended.

You can follow Apex's advice regarding how to split your Roth/regular 401k contributions from the GP Reader Profile post. Your tax bracket is high enough that you will probably be in a lower bracket in the future. Near the end of the year you can toggle your witholding to bring your taxable income under the 28% tax bracket threshold.

*correction, with utilities I meant to say cable, internet, phone.

Thanks for all the feedback so far. In terms of Roth/Traditional debate, I have been going back and forth on this. I agree all else equal we are likely losing money, but what are the odds tax rates in general increase over the next 30 years to pay for years of abuse in D.C.? Our bills as a country will come due, so my rationale has always been to get in with our current tax rates. I do see I am contributing less since it is post-tax so I very well may flip the contributions to still hedge for tax rate increases but gain more current favorability.

The loans are a royal pain and I agree we need to cut back on non-essential home improvements to get this done. There are many things I would love to do, but i would also love getting back $900 a month in loan payments even with rates at a reasonable level. Once we get E-Fund to a comfortable level we are going to start taking all discretionary income and pouring it into the loans. At worst I would like to knock off the higher interest ones to get my blended rates down to around 2.50%, which is where some of my loans are locked in at.

@ Luis I am not sure we are house poor, but our liquid savings are a bit depleted since we learned first hand that the first year in a house is indeed expensive and we paid back an $8K loan to my wife's mother as she had helped us with our down payment. We pour over $1K monthly into our various targeted savings, so we should be able to build up a decent base in 2013. And our bonuses should get us to 6 months of mortgages, which is a decent start for an E-fund.

I think if we cut out the monthly home improvement ($400), and shop more frugally food and other areas, we can squeeze out an additional $1000 per month and not feel the effects all that much.

I really do struggle with what to prioritize the loans or PMI. General feedback has been to reduce PMI, but I just can't get past the fact I have been paying these loans for 10+ years now and I still have a large number to pay back.


Hi PD,

You need to improve your cash flow.

Taking advantage of company matching is smart. Is this 100% matching or partial matching and up to what %? Can you further detail this? I'd say contribute only as much as you get a match for...

Then- pay off your PMI first to free up cash flow, then focus on the student loans. Your mortgage payment is a big part of your take home income so if you can then pay this down (after PMI and student loans are completed) that would be best. You also should try to cut your expenses more and hold off on further improvements unless really needed.

Structurally you have a lot of your income tied up in fixed costs and this is not good. Having children will tie up more of your fixed costs so if you could wait a few years that would be good since it may risk your wife's income after having a child- potentially.

Hang in there and improve your cash flow, you will be happy to have the increased flexibility. Also if you can keep growing your income while keeping your lifestyle constrained then you can increase your savings and cash flow every month. This needs to be your top priority, in my opinion.

Best of luck.

-Mike

I'll try not to duplicate previous comments.

@PD I'd consider prioritizing your wife's loan since it only has $2500 left and that'll chop $250/month out of your required monthly cashflow. If PMI is more expensive than your student loans, it makes more mathematical sense to get rid of it. It sounds like what you need is a plan, a timeline, and an ordering for when you would have these all paid off.

If you pay down the mortgage to 20% and eliminate PMI, you might be able to refinance into a new mortgage with a lower rate (closer to 4%) and since you would have a lower loan balance, have a lower payment, which would help with cash flow AND you would be spending less money on interest each month.

Have you considered asking your work to cover your cell phone? Do you use it for work?

If you're planning on having children ASAP, do you know what your health insurance looks like for pregnancy and childbirth? My employer offers a few choices and they have varying levels of maternity coverage. How would your or your wife's pay be affected by taking parental leave? That is really important to know as well since some employers don't offer paid leave at all. Would you be prepared to not have your wife's income while she was on maternity leave?

I bought a condo last year and I've spent a good amount on home improvement, but I had set aside money for this prior to purchasing. I spent < $200 on the "needs" prior to moving in and now keep a prioritized list of wants and pick one or two off each month.

You shouldn't include these in your savings %: Home Improvement Fund, Travel Fund, Gift Fund. They'll be spent pretty short-term.

I think your doing great, just keep paying debt, trim down CVS and Clothing funds to contribute half towards debt payoff and emergency savings.

@ PD regarding debts/deficits and taxes

I do not think that tax rates will rise without a fight from the lower and middle class. It is a large constituency group compared to the top 2%. Therefore higher tax rates will more likely be a problem for those in the high income producing years and not for retirees. Remember, you will only need to withdraw the minimum amount to cover your yearly expenses.

Second, the debts will never be completely paid off, it will always be a percent of the GDP. Whether it is a healthy proportion is the main issue to debate. I'd say that debt is currently high over GDP only because GDP is low. Government spending is already below historic averages. The majority of economists will tell you that austerity measures to reduce spending will only reduce GDP even further and worsen, not help, debt over GDP.

The debt and deficit problem will eventually correct itself in what has been to date a sluggish recovery in the economic cycle (due to the great recession). You can look to California (of all else!) for signs of positive light in news of their recent balanced budget proposal.

http://www.bloomberg.com/news/2013-02-20/california-a-high-revenue-low-services-state.html

Your employer match goes to the traditional 401k, so you are effectively 50/50 on the combined contributions. This is what works for us as well - we are in higher tax bracket than you so if we go by the numbers maybe doesn't make sense, but makes us comfortable to be balanced.

Personally I would prioritize PMI, because that goes with getting more house equity so that you can have flexibility for refinancing or even selling (you never know). And the rate on student loans is lower

Don't cut the cleaning lady (or cut now but get her back when you have the baby). We got cleaning service for the first 4 years of our kids, was great as you really have no time to clean properly, esp if both working in demanding industries.

Figure out what's in these CVS/Target, etc trips. You could have better visibility in your spending. We started using Mint and are quite happy.

I'm confused about your mortgage payment - you say it's $3,100 including $285 PMI, and is a 30-year loan at 4.1% with a current balance of $450,000. Based on the loan balance, your payments should be about $2,200 not including PMI. Alternatively, based on the payment amount, your loan balance should be about $570,000. One of those numbers isn't making sense, unless you're paying a bunch extra on the mortgage each month without telling us.

@Jonathan It's possible that they're escrowing their taxes and insurance. Some counties have pretty high taxes.

@ Mike - We contribute 15% each to 401K with our companies matching 6% on top. Yes freeing up cash beyond our targeted savings will be key in freeing up cash for our imaginary baby. We are both 33 so waiting a few years is not an option. We are ready now. the overriding theme seems to be pay down PMI first, so we will knock off the wife's loan quickly and then shift focus to PMI.

@ Leigh - My wife has top notch health insurance, so we are pretty set there. care to elaborate on why the short term liquid savings not being included? I include it only because in a true emergency it is there for us to use. It is "earmarked" for specific things, but it is still liquid and available for true emergencies. We do not consider it part of the E-Fund but in a pinch we could use it.

@ Ivy yeah we are about split evenly with company match, but wondering if it makes sense given our current salaries to adjust slightly more heavily to the traditional given the feedback here and what I had previously thought.

@ Jonathan - our current loan balance is about $455K. $2200 in P&I, $285 PMI, and about $600 monthly goes into escrow to pay for quarterly property taxes and homeowners insurance renewal to arrive at the $3100.

Roth/401k

One important fact to remember that many overlook is that your decision for what type of vehicle to use does not depend only on the difference in current and future tax rates. It also depends on what tax bracket you expect to be in. I currently save a large portion of my income (~50%) and expect to retire when my current expenses can be comfortably covered by my savings. I am setting myself up to drop to a substantially lower tax bracket in retirement. Even if tax rates rise overall it is extremely unlikely that my future lower bracket will exceed my current marginal rate, for that reason I personally favor deferred tax options.

PMI/Student Loans

The mortgage payment listed included insurance and property tax I'm sure and the property tax looks to be pretty darn steep. Don't be concerned about your PMI as "throwing money away". PMI is simply a penalty rate applied to your loan because of your riskier LTV. It's just a cost of financing your home, fundamentally no different than the interest rate you pay on your mortgage. Of course you want to pay as little as possible to borrow money so you'd rather not pay it at all but the important thing is to remember it's not inherently any better or worse than any other finance charge. What matters are the numbers.

This is the proper way to view your PMI payment in relation to other debts. Assuming your house was 500k, your loan was 90 LTV and 450k and rate was 4.1%. If you had taken out an 80 LTV loan for 400k at 4.1% you'd also have had to borrow the additional 50k as a 2nd lien of $50k. The $50k 2nd has the base 4.1% rate plus an additional $285 monthly payment that comes as PMI. (.041 /12 * 50000) + 285 is $486 in expense per month. That's an annualized rate of 11% on your $50k 2nd lien. That's pretty expensive money, if you had $50k in cash you would be crazy not to pay down your mortgage before the student loans.

The math there isn't exactly right, the PMI payment is fixed regardless of the dollar amount your loan exceeds 80 LTV but conceptually this is a simple way to think about it. PMI isn't necessarily a bad thing but it is not a cheap way to borrow money.

@ Bill - Thanks for the insight. Really appreciate the post. Let me ask you this. Since it is apparent we do not have the $50K necessary to remove PMI, what would you do if you could pay down debt in smaller increments of say $500-$2000 at a time? Would you still keep focus on paying down PMI or would you bang out the loans? As you said, PMI is fixed regardless of your current loan balance until you hit the magical 78-80%, so paying say $500 extra per month might equate to two extra payments per year, but will that drastically reduce the time I am paying PMI? I would argue that unless I could more or less pay off the PMI in one fell swoop, paying down the student loans might be the way to go as I know that higher payments equates to lesser interest paid.

And I am now convinced after yet another argument on tax deferment from you to swap my Roth/Traditional percentages. Going to do that soon.

Lots of good advice so far so I won't double down on that.
I would recommend looking into your property taxes. Check the mill rate and the home valuation. If you purchased recently and the 2nd floor needs work, it could be that the town's assessment in too high. Last year, I got my home value reduce $25K by challenging it and bringing in the assessment from my refinancing as evidence. My property taxes decreased $100 per month.
Also, if you're planning on starting a family. The year I had children, I accumulated my 7 weeks of vacation time so I got almost a full 13 weeks of paid maternity leave. Short term leave covered 6 weeks but vacation time kicked in after that so I didn't go without a pay check for 3 months.

The PMI is an amount that you need to pay based on the LTV of your mortgage. "Paying off PMI" is really just putting your money into your mortgage, which still gets you a 4.1% return, greater than your student loans. Even if your loans were 4.5%, I'd still say the mortgage because eventually you will get a huge bonus when PMI drops out of the equation.

Unless one of your loans has a super high, 15% interest rate, pay off your mortgage.

You could do an in depth analysis to account for the discontinuous nature of the PMI if you wanted but in your situation it's not necessary. If your student loans are at 3.75% and your mortgage is at 4.1%, both are fully tax deductible, paying extra to the mortgage is saving you on interest expense no matter what. The PMI release is just an extra kicker.

Paying off the lower rate student loan faster doesn't save you any money, your paying down 3.75% debt or 4.1% debt. The only reason you'd want to pay off the student loan first (which could be a perfectly valid reason) is to free up some cashflow.

With no increase in home prices at minimum payments you'll hit 78% ltv in 82 months, with $500 a month prepayments it will take 49. That's $9500 in saved PMI on top of the small savings from interest rate differential.

@ Indio - We live in a fairly expensive town so the $6K or so in property taxes is in line with reality. Our house is fully completed, we would just like to re-finish our third floor attic space at some point, which I am sure will raise our taxes further. Re: maternity leave, my wife carried over 20 days, so she will have an extra month. I too plan on hoarding days once I "knock her up"....

@ Bill - That is the exact reason why I despise my student loans. It hurts the monthly cash flow, which is what we are trying to create with a future family to put through daycare. So the garbage I signed where I would hit 78% during close in something like December 2017 is not correct? Or are your numbers a rough estimate?

Ha seems easier when we were renting. So many damn options!

the other thing holding me back, and I understand it is totally mental, is how LARGE the mortgage is. I have two secured debts I owe, one is $30K and the other is $450K. I understand the math says pay down mortgage to remove PMI and get a 4.1% return on our money, but there is also something to be said about paying off a debt I have had for over 10 years now. I know it is money towards debt either way, it is just tough getting over that mental hurdle that says, "Yeah you are going to end up paying off your student loans until you are FORTY"....I see the math and appreciate the feedback, now I just need to formulate a plan. I think removing the wife's debt from the ledger is a good start, and then at worst earmark the new cash flow towards the mortgage with the potential to direct larger sums there until at least PMI is gone.

@Luis,

You are correct that raising taxes on the lower and middle class will be a tough sell, that's why my opinion (and that's all it is, because guessing about future tax rates is a fools errand ... one which I am about to participate in) is that what is more likely to happen is for income tax rates to not go up much more but for there to eventually be the introduction of a VAT tax or sales tax system. Most European nations that spend more than us found they could only take income tax rates so far and then they had to go to a more broad based consumption based tax to get the rest. I suspect we will find the same thing.

I am not sure why you entered into the austerity argument based on his question on taxes but your point about California balancing its budget seemed to imply they grew out of it but even the title of the article you posted lays it out as a high revenue low services solution. They balanced it through some austerity and a large tax increase on the upper income, which I believe you are proposing as not the likely or at least not the optimum solution, but I can't quite tell for sure.

You did make one statement about current spending that is incorrect. You said "I'd say that debt is currently high over GDP only because GDP is low. Government spending is already below historic averages."

First of all GDP is not low per se.

http://www.calculatedriskblog.com/2012/07/real-gdp-increased-15-annual-rate-in-q2.html

It is lower than its previous trend and lower than it could be if we had not had the deep recession but real GDP is actually at all time highs, just probably a trillion or so below the trend we were on (a trend I would argue that was inflated due to the housing bubble but that's an opinion I can't easily prove). Of course every recession decreases GDP, that's part of the definition of a recession, this one was just a bit bigger of a decrease so it hurt more.

The decrease in GDP of a 1 trillion below previous trend has certainly lowered projected tax receipts perhaps to the tune of as much as 200 billion, but the increased spending has been far more responsible. Historical trend since WWII is for tax receipts to run in the 18% range and spending to run in the 20% range. Tax receipts got down to 15% and spending went above 25%. Right now taxes are at 17% and spending at 22% With the CBO projecting taxes to rise to 19% of GDP and spending to head towards 23% of GDP over the next 10 years and that all assumes no recession in the next 10 years which is unlikely.

http://www.mygovcost.org/wp-content/uploads/2013/02/cbo-revenue-spending-history-1962-to-2012-and-projections-to-2023.png

So I am not sure why you think spending is at historic lows when it reached historic highs a couple years ago and is still above trend and projected to stay there indefinitely.

@ Apex

When I said GDP is low I mean to say that it is not where it needs to be both in context of 4 years of lost growth and unemployment not back to normal (potential revenue lost). Just because real GDP is at an all time high means nothing in context of other factors.

http://www.calculatedriskblog.com/2013/02/update-recovery-measures.html

Government spending has not increased over the last few years. The best way to track spending would be by setting it against per capita (not GDP as we all know GDP fluctuates with the state of the economy). In fact, I'd say 22% is not all bad considering!

http://economistsview.typepad.com/economistsview/2012/03/per-capita-government-spending-by-president.html

Lastly, projections do not consider actions yet to be taken. Taxes will rise to 23% of GDP if and only if congress does nothing to intercede with pressing issues such as escalating health care costs as an example.

Check the terms of your loan before you assume PMI will go away once you hit 80%. My FHA loan, which is a couple years older than yours, required 80% AND paying PMI for 5 years total. If you cant find it in your loan docs get it in writing from your bank as the phone reps tend to be uninformed. Granted you should know all of this because you are a VP of Finance at a bank.

"@ Luis I am not sure we are house poor"
Your payment is quite substantial. Ex-retirement your net worth is negative, you are on a 17 year plan for paying off student debt and planning on going another $15k in debt for a car. Yet you're spending nearly a grand a month for house cleaning, home decor and clothing. You budget leaves like $85 for savings/buffer and you want to throw a kid in the mix. You're house poor.

@ Adam: We put nearly $1000 a month into E-Fund and other liquid savings vehicles. the above breakout was after we paid ourselves with savings. The $7200 breakout is exclusive of that, so saying we have $85 a month for savings is an incorrect statement.

Yes I am on the 17 year plan to pay off college, but I was also making $55K a year 2.5 years ago, so we did not have the disposable income to begin paying down our debts. I agree we can trim the fat a little to focus on downsizing our college loans and paying down mortgage, but we are certainly not working with wiggle room of less than $100 per month.

Apex, I disagree about us eventually getting a VAT. I think raising rates on existing taxes is a easier sell than adding an entirely new tax structure. I speak from experience seeing how it works in the Northwest. Washington has sales tax and no income tax. Oregon has income tax and no sales tax. Every so often WA tries to add income tax and OR tries to add sales tax and every time the idea is shot down by high majority. I just don't see people agreeing to a VAT being added on top of existing taxes. Everyone sees that as just another tax that can be raised and won't be removed. Thats why OR & WA vote em down everytime. Yet the income tax in OR creeps up and the sales tax in WA creeps up. I don't expect the politicians in DC to propose adding a VAT. I can't seeing that having any significant support in the electorate or in congress. They may however jack up other tax rates in other ways. Marginal increases to payroll and excise taxes could get through and a whole lot easier than adding an entire VAT system.
Just my opinion of course.

I'd say being "house poor" after putting 40K/year into retirement and another 10% of take home into additional savings funds is a good thing, rather see the money put into a real asset than more trips to Target or a BMW.

@Luis,

"Government spending has not increased over the last few years. The best way to track spending would be by setting it against per capita (not GDP as we all know GDP fluctuates with the state of the economy)."

OK, if you think don't like the GDP based data, here is total federal outlays per capita in real inflation adjusted dollars:

http://mercatus.org/sites/default/files/Federal-Outpays-Per-Capita-For-Web.jpg

Highest ever per capita. Almost $2000 higher per person than under Bush and Bush was $2000 higher per person than under Clinton. That does not fit with your statement of spending being below historical averages, GDP based or otherwise.

The fact that it is flat the last few years after an unprecedented jump in 2009 is quite irrelevant. In fact it could be flat for the next 40 years, it would still mean a higher level of spending per capita than at any time in history. Certainly not below any historical averages but more above the averages than at any time in history post WWII.

The point is not to assign blame. There is plenty of that to go around. But there is no possible way to make a case that spending is low now compared to any historical account.

@Jim,

You may be right, like I said forecasting taxes is a fools errand which I waded into. I just speculated on that path since I don't see anyone with the stomach to raise rates on the middle class and eventually they are going to need some more of the middle class money. They have to find some way to get it. But you are right, it will be fought and by both parties so maybe it won't happen.

However, even though your regional example shows the fight against it, there are about 75% of states that have both income and sales taxes. I am not sure the history of how they were passed but it is not exactly as if it's a rarity in the states. The vast majority have both.

@PD: After reading your comment I see I misinterpreted the pay yourself first paragraph (I assumed it was included the spending categories listed below). Now that I understand your system a bit better, *if I were you*, I would pause that system and put those funds in to paying off debt. Also most of the $250/pay period/person ($1k/month?) spending money.

Just think: If you lived bare bones for 6 weeks you could pay off your wife's student loan. Early April instead of "before the end of the year."

As far as the prioritization of student loans or paying down mortgage to get rid of PMI...assuming your student loan is fully tax deductible getting the $50k or so to dump the PMI is probably the most “bang for your buck” in terms of saving fees/interest. However, writing a check for $50k today to get rid of PMI would only improve your cash flow by $285/month (PMI), less the foregone tax savings. Since you are thinking strongly about kids I would hammer the college loans as it will give you a greater cash flow to pay for that babysitter.

After you pay off PMI, you may want to refinance, as 4.1% is rather high, even for a 30 year fixed. I know many are opposed to ARMs (I personally think they make a lot of sense depending on one's circumstances). By way of example, we just refinanced into a 5 year ARM with Penfed for 2.5%. Our rate cannot increase more than 2% every 5-year period. PenFed paid all of our closing costs. It's something to consider as it would free up quite a bit of cash for you each month. The payment on our $350k mortgage, including escrow, is ~ $1500.

Apex, Yeah most states have income and sales tax. But I suspect both have existed in most states for a long time. But once things have been one way or another for a long time people get more resistant to changing it. We've never had a national sales tax in the US and I doubt people will welcome one in the least. OR & WA are in unique situation of not having a class of tax and you can see how resistant people are to adding a tax that doesn't exist.

But as you said predicting how taxes will pan out in the future is a fools errand.

Looking at you numbers I have to say that overall you're in pretty good shape. You have no debt other than th estudent loans and mortgage, that's fantastic! I would definitly tackle the PMI and get that out of picture. I can understand not being able to pay more than 10% down on a 450k home, it's one reason I left NYC and moved to North Carolina! (Although it goes against the grain of what I normally think about 401's (contribute early and as much as you can) you may want toconsider paring down your contributions to the 401k and using the funds freed up to tackle the morgage so that you can get it down to the LTV needed to get rid of the PMI. Alternatively you can use those funds to pay off student loans and then tackle the mortgage.

Lots of good advice here. I will comment on PMI. When I bought my current home I did not have full 20%downpayment. My broker introduced me to a new product. Pay a lumpsump (.000168%) one time PMI and avoid a monthly PMI . I not only did that but rolled it into the loan. The way I see it that it would have taken me 7.5 years to reach 20% equity (not accounting for appreciation) but I would break even in 3.5 yrs with one time payment. So if interested consider refi with this feature. I used a broker but believe Wells Fargo offers this product.

I'd go after the student loans before the PMI.

Reasons:
Your household income exceeds the threshold for deducting student loan interest, but you can still deduct mortgage interest.

You mentioned that you had a set of student loans, rather than a single loan.

Because the individual student loans are likely lower amounts than the sum you'd need to get rid of PMI, you can start to free up cash flow a little at a time - knock off the wife's loan, free up $250/mo. Knock off the next loan, free up another $100-300/mo. and so on - you can rack up "wins" in the form of extra breathing room faster. This is critical because you don't know how quickly your wife will get pregnant once you start trying. Some people assume it'll take 6 months and it happens in a matter of weeks...then they're under-prepared.

FWIW: I am 30, and using the same strategy to pay off my MBA loans and manage my cash flow, in anticipation of having kids and daycare expenses.

I would focus on getting rid of your student loan debt before worrying about paying down the PMI. After that I would definitely pay the PMI down. Keep saving for retirement, build up your savings to your desired level, then knock the mortgage out as soon as possible. Getting rid of 3100 mortgage would make 1700 in childcare a breeze!

@ Adam - yeah the spending money is a bit high, but we do use that for all discretionary spend we have. We used more of it when we lived in Boston, but now that we are out in the burbs we spend less of it as we do not go out as much. We can definitely divert much of that to pay down the student loans. Once we get eh E-Fund to pre-house levels, we definitely plan on diverting much of that to the loans. Thanks for the insight.

@ BH - we go through Wells Fargo, and even with our solid credit (800+ wife 780 me), the cost/benefit of re-financing is not worth it. if we had 20% equity we could get rates closer to 3.5%. It is enticing to be able lock in that rate by building equity, which is why I have my dilemma on what to pay first.

@ Aks - I will look into that as we use Wells Fargo. Thanks!

@ Margo - You are correct that we cannot deduct student loan interest on federal taxes. We still can on our MA return, but the benefit is shrinking....We also cannot deduct PMI as it phases out after AGI of $100K. But I totally agree with your idea of freeing up small amounts of cash flow. Once my wife's is paid off, I will work towards paying off each one of the three loans I have as that will slowly free up cash. We think that ultimately this way will help us free up the cash flow for daycare for one of the kids. If we have two (and we would like to), might have to get creative to come up with the second daycare payment. Although hopefully at that point our incomes will be up to the point it will cover it. Thanks for the advice!

@ Nick - Yeah the lack of mortgage would be tremendous. Your order sounds about right.

Thanks FMF for letting me participate. It has been informative!

Bill pointed out that for the PMI :
"That's an annualized rate of 11% on your $50k 2nd lien.

You should definitely prioritize PMI over the student loans.

Back to square one. PD, I feel like you are trying to apply debt snowball strategy to your loans. These are not credit cards, difference is amortization. You can probably get away from paying your wife's student loans first only because it is going to be quick. I tell you what, run the mortgage and your student loans through an amortization calculator online and see the difference in interest saved through accelerated payments.

All good discussion so far.

But I am a little surprised no one has mentioned the risk of having a $450k mortgage based on two incomes about equal, with plans for kids shortly. Assuming everything goes normally, you will have lost income of almost half for whatever period she is out, then cost of child-care for an infant, extremely high. Then likely going through it again not too far out if you want more, and are 33 already, then child care for two young ones, even more expensive.

I have seen it too many times, mortgage based on two incomes, one income goes away or is cut drastically, and now there are major issues. Complications from pregnancy, fertility costs, general layoffs with no notice, wifes thinking they will go back to work but reevaluating after the baby comes, etc...

I would strongly recommend paying off the wifes student loan because so low, cut retirement back to lowest matching amount for both, and go for a higher Emergency, maybe a full year's expenses. Then go back to hit the Student loans, then bump up retirement again. I wouldn't touch PMI till all that is done.

You said the odds of losing both jobs at once are very low, that is probably true. But with your life situation, the odds of one going away for an extended time are a fair risk. And with her income almost half of total, it makes the impact of the risk very high. As a VP of Finance, do a full Risk Analysis, with mitigation steps(Emergency fund or others if you know them). To me, this is more important to overall picture than the smaller issues being discussed.

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