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rob0086
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Retire Planning  Reply with quote  

Need advice on two options regarding paying off my mortgage and retirement saving. I am 53, married, w/ two college age girls, and my wife and I currently owe ~$290,000 on our mortgage, which is underwater by about $30,000. Monthly payment is $2,400. Have ~$40,000 saved in my 401K. Which of the following options should we pursue, or is there another option we haven't thought about? Goal is to accumulate as close to $1,000,000 in savings as possible by the time I am 67.

Option 1 - Sink every dollar we can muster into paying the mortgage completely off (in about 7 years) and THEN dump everything we can into retirement savings every month, OR

Option 2 - Pay down the mortgage over the next couple of years to the point where it is no longer under water, then refinance to hopefully bring the monthly payment to ~$1,500, freeing up an additional ~$900/month for my 401K.
Post Sat Nov 08, 2014 6:56 pm
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oldguy
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Your Net Worth is about $10,000. (The 401k $40,000 - the negative house equity $30,000). Going from a NW of $10,000 to $1,000,000 in 14 years is a tall order. (Coincidently, that is about what my 401k did between 1984 and 1998.)

To do that, you need to put whatever you can, as early as you can, into 401k funds that typically have a longterm average 11%/yr (the historical US market average). The "as early as you can" is important, you need the power of compounding to work for you over many years.

If you invest $2500/m at 11%/yr for 14 yrs, it will be $1M. Here's the rub, 11%/yr is a 30 yr average - so, with only 14 years, you need to be flexible - eg, if there is a market crash in Year#12 or #13, you need to be able to wait it out, work a couple more yrs. Or, if the market averages 14% or 15%/yr for a couple yrs, you need to back away early and protect your $1M.

Your option #1 - No, that is backwards - prioritize your wealth-building, put every dollar into the 401k and get the compounding started.

Your option #2 - No, still backwards, apply that money to wealth, not to debt. Additionally, never BUY equity, wait a couple years and let the housing market GIVE it to you. (That $30k, on a $260k house, will probably come to you for free in 2 or 3 yrs, don't waste your capital on that.)

BTW, what are the terms of your mortgage - 30 years? Interest rate? Fixed rate or variable?
Post Sat Nov 08, 2014 8:30 pm
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rob0086
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30 Yrs @ 6% fixed, but I'm stuck being under water. Can't refinance and can't do the HARP thing, because it's not an FHA loan. I have a little bit of discretionary debt - car loan and line of credit that together suck up ~$300/month, so I guess my focus should be to eliminate this debt (which I could do as early as the spring of 2015 with company profit sharing and overtime) and then funnel the free cash to the 401K??
Post Sat Nov 08, 2014 8:46 pm
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oldguy
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The 6% loan isn't too bad, definitely not a 'toxic' rate. Keep it for now, in 2 or 3 yrs the house may be worth more than the loan and you'll be able to refi at a lower rate (without having to use your own money).

And I would keep the $300/m debts and concentrate on investing the extra money at 11%.

It seems counter-intuitive doesn't it? - people always feel the need to prepay debt 'just because it's there". But do the math - if it makes sense to keep your loans, keep them - that's seed money for your wealth building.

Here is an example for you to consider. Borrow $50k @ 5% for 30 yrs, that costs $268/m, a total of $96,600 over 30 yrs. Place that $50,000 lump sum into an 11%/yr index fund for 30 years, it will be $1,145,000. Few people consider the power of compounding, it is hard to grasp.
This is what I've done with my rental houses over the past 39 years - whenever a house grows some equity, I refi it and take out the cash - then I invest the cash elsewhere.
Post Sat Nov 08, 2014 10:14 pm
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rob0086
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Makes sense. Thanks very much for the sound advice. I really appreciate it!
Post Sun Nov 09, 2014 12:20 am
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Wino
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Do the Math  Reply with quote  

Rob says he can pay off the mortgage in 7 years, which works out to about $40K per year, ignoring interest paid. He's paying $2400 per month now. That's $28.8K, leaving him only about $1900 per month to invest above his house payment, which he will STILL have to make using the "invest now with borrowed money" method. That means that even at 11% fixed (ignoring volatility), he's only going to have $750K or so in 14 years.

His best bet would be to put as much toward his house as possible, and eliminate all other debt. After that, he can put as much money as possible toward his retirement. If he were to pay off his house, and then invest the entire $4300 per month for 7 years, he'd have about $540K (at 11%) AND his house would be paid for.

So, using the borrow-to-invest method, he'd have $300K more in his retirement, AND he'd still have a house payment. I'll show the excel spreadsheets if you like, but they are simple pmt and fv equations. Also, they ignore volatility, which means that a shorter term evaluation (7 years for mine; 14 for yours) will be more likely to match the figures than a longer term. It also means that the longer term figures will be lower, not higher, using the annual (higher) versus average (lower).

rob0086: Pay off the house and then start your saving. You'll have 7 years of "peace of mind" of having the house paid off, and then you'll see your retirement savings grow. Also, you never mentioned your income, other debts, or similar. I would think that by cutting back your lifestyle, maybe getting a second job or doing some contracting work outside regular hours, or otherwise increasing your income to outgo ratio, you'd pay off the house even more quickly and then apply the additional to your savings for investment.

I'm in much the same boat as you concerning age and stats. My house is nearly paid off, but I continue to invest while paying it down. I will have $1M in my retirement accounts before I'm 67, and I was in much worse financial shape than you, only a very few years ago. Compound interest is nice, but saving $12K per year for 30 years still loses to saving $120K per year for 10 years when you factor in inflation and volatility. This is why I use 8% for my calculations instead of the "average" of 11%.

If you use Excel, I can write spreadsheets to show you why using the "average" return in your calculations will be overly optimistic compared to annual rate of return. This is sorta like those "APR vs APY" signs you see in banks sometimes. Your actual money will only grow at the 11% rate if the markets do not change. The more they vary, the farther you will be from the average rate of return, and it is never in your favor.

The classic example, albeit one that is not very realistic: You have $100K. The first year you make 100% ($200K). The second year you lose 50% (back to $100K), but your "average" rate of return is 25% ([+100-50]/2), yet your money is the same as you started. Your annual rate of return is 0%. Again, this is an unreasonable example, but it shows the effect of average versus annual in financial calculations.

I suggest you pay off your house more quickly, then put every penny you can toward retirement using good index funds at a no-load, low-fee fund manager/brokerage like Vanguard, Fidelity, or T. Rowe Price. You will be making guaranteed progress (paying off 6% debt), rather than hoping for a continuation of historic market performance (which is a good bet, no doubt) which may or may not work out in your favor.

Your goal of $1M before you're 67 is attainable, but you need more income or less outgo.
Post Sun Nov 09, 2014 4:47 am
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rob0086
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Wino, thanks very much for your input! I would like to see your excel spreadsheets.

Last edited by rob0086 on Sun Nov 09, 2014 2:25 pm; edited 1 time in total
Post Sun Nov 09, 2014 2:05 pm
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Wino
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quote:
Originally posted by rob0086
Wino, thanks very much for your input! I would like to see your excel spreadsheets. Whenever you get the chance, you can email them to XXXX

Please check your PMs.
Post Sun Nov 09, 2014 2:19 pm
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Wino
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Here's a spreadsheet I did about a year ago. It allows you to compare two investments.

Read the notes. Any box with a highlight (yellow or gray) is there for you to change the values. If you select an annual rate, it remains that rate unless you change it on one of the years. It will then remain that new rate until you change it in a later year.

Let me know if you'd like changes.

https://db.tt/ShdZb7qN
Post Sun Nov 09, 2014 2:46 pm
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oldguy
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wino - in your calculations remember, about $650/m of that $2400/m house payment is Tax/Ins. That goes on forever, even after the house is paid off. Nor does that $650/m go toward paying off the house early. Very Happy
Post Sun Nov 09, 2014 5:39 pm
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rob0086
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Good point. Thanks!
Post Sun Nov 09, 2014 5:43 pm
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Wino
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quote:
Originally posted by oldguy
wino - in your calculations remember, about $650/m of that $2400/m house payment is Tax/Ins. That goes on forever, even after the house is paid off. Nor does that $650/m go toward paying off the house early. Very Happy

I always forget that because I don't escrow. I've always said, "If you think you own your house, just try not paying your taxes for a few years and find out who the real owner actually is."

And due to the above, I am really, really against property taxes. One should be able to actually buy a house, not rent one from the government indefinitely.
Post Sun Nov 09, 2014 6:06 pm
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rob0086
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I'm for that!
Post Sun Nov 09, 2014 6:31 pm
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