Ask the grumpies: What to do with 25K and some other concerns

Pondering25K asks:

I have a financial question that my spouse and I have been mulling over for a few months and wondered if we could tap into the expertise of you and your readership.

Here’s our situation.

We have about 25K to throw at some of our debt, and can’t figure out the best place to put it. Our feeling is that both major options we have thought of are good, but we’d like more advice.

We have a 30 year fixed rate FHA mortgage with a 3.25% interest rate that we have been prepaying about 800 extra per month (our interest + principal payment is 1500). The mortgage currently still has 27 years left, since we refinanced a few years ago. We have a $335/month PMI payment that will go away in 2 years if we reach 80% loan-to-value ratio. This will happen if we prepay with the 25K. If we don’t prepay with the 25K now, we will have to prepay more than we are currently each month to reach the 80% loan-to-value ratio. We cannot re-amortize our FHA loan to recover this cash in the future.

We also have a car loan with a 2.99% interest rate and about 5 years left (it had a 6 year term) that has a $405 monthly payment. The payoff balance is slightly under the 25K, so we could kill this loan now.

We have a better-than-required amount of money saved for retirements in IRA, 401Ks, and a teacher retirement plan, and are maxing everything out already. We also have started saving for our toddler’s education in a 529, and contribute $260/month to that.

My salary is 60K, but will go up each year as I just started as a teacher and will move up the step system. It is pretty secure, unless our state budget was drastically cut and they got rid of my entire school system (it’s run out of the state Dept of Ed).

My husband’s  base salary is 130K, with bonuses that are pretty significant, but not guaranteed. His job itself stable, but he’s not happy there. If he were to find a job he liked, it would likely involve a change to a much lower paying career, or starting a small business of some sort.

We can’t re-amortize at any point (a major disadvantage to an FHA loan). We have thought about refinancing to have a mortgage where we could, but the interest rates are higher and closing costs would be around the same as the amount of PMI we would pay in the next two years.

We are torn between lowering our monthly expenses now and saving money long term. Both of these are important to us, as we would like flexibility in case of job loss or the desire to switch to lower paying careers. We don’t want to be trapped by our mortgage payment.

Standard financial disclaimers apply.  We are not financial planners and everyone should do their own research and/or consult with real financial planners before making major financial decisions.  Our opinions are opinions, apply at your own risk.

First to answer the question you actually asked:  Should you put the money towards your mortgage or your car loan?

Unless I’m missing something [UPDATE:  See discussion below about FHA loans compared to private industry loans– depending on the circumstances, I may have missed something], paying down enough to get rid of PMI dominates (or matches) the benefits of paying down the car loan (assuming you’re not planning on ever declaring bankruptcy, foreclosing, or getting a car repossessed).  First, it has a better return on investment given that 1.  You’re still early in the mortgage, 2. the interest rate is higher, 3.  PMI is a big additional chunk.  Second, dropping a $335 monthly payment isn’t really that far off from dropping a $405 monthly payment in terms of solvency given the numbers you’ve been throwing around, so if you need to lower required monthly payments you’re not actually gaining that much from paying off the car vs. getting rid of PMI.  Not nothing, but there are other places to cut that would give you more bang for the buck.

And now for the question you didn’t ask.  You’re currently making 190K plus bonuses.  You are very high income.  It’s great that you’re putting so much money away in retirement, but unless you have (and are using) the ability to put insane amounts of money away for retirement (for example, you’re saving in a 457 plan in addition to the standard pension, or your spouse is putting money in a Mega Backdoor Roth IRA), you might want to try cutting  your spending and funneling the extra money towards a large emergency fund and possibly some taxable investments.  Why?  You note that your DH is not happy with his job and may want to leave the job for a lower paying career or starting a small business with its attendant risk.

Think about what kind of paycut he is likely to have, and run some emergency scenarios (a financial fire drill in the words of Donna Freedman).  What savings would you stop?  What spending are you required to make?  What changes might you need to make long term?  How much would your DH need to bring in to supplement your salary given the step schedule?  Once you have all of that information figured out, try living on the new salary just to see what it’s like.  While you do that, funnel that money you’re no longer spending into a healthy emergency fund that you can easily access and into your car loan in order to decrease your required monthly payment (2.99% is a low interest rate compared to long term investment, but it’s higher than what a savings account will give you these days).  This will allow you to feel what it’s like to live on a lower income and make adjustments now while there’s no danger from making mistakes while also saving up so you will be able to weather emergencies while on that lower income in the future.  (This is also a standard recommendation for planning for a spouse leaving the labor force to take care of a child.)

There’s a lot to be said for being able to let a beloved spouse quit the job he dislikes if he wants to, even if it brings in a good income.

Books you may find helpful:  Your Money or Your Life, All Your Worth.

Note here that if the couple were lower income, I would suggest cutting some of the long-term savings rather than spending to boost short-term savings for two reasons.  The first being that lower income families get more financial aid so the 529 should be a secondary consideration after PMI and after the car loan.  The second would be that they would already be spending less and would both have less slack in their budget now but would also be unlikely to have to cut as much spending later (as the going from 130 to a lower salary isn’t as big a drop as 50 to the same lower salary).

Additionally, if they didn’t want more flexibility, then their current plan would probably be fine since their jobs are secure.  But the need for freedom is important, even if that freedom is never acted upon.  The ability to leave a job is a wonderful freedom to have, and worth more than a lot of kinds of spending.

What do you think, grumpy nation?  Did I miss anything with the 25K?  How about the other advice?


22 Responses to “Ask the grumpies: What to do with 25K and some other concerns”

  1. Leigh Says:

    “We have a $335/month PMI payment that will go away in 2 years if we reach 80% loan-to-value ratio.”

    I like what you said! What stood out to me was that the PMI payment won’t go away until TWO YEARS from now. So why pre-pay with the 25K chunk now? They won’t see any of the benefit for two years. So with that knowledge, I would definitely consider using this money to increase their emergency fund in the meantime and either using this account to make extra monthly mortgage payments over the next 2 years OR to use it to make a big pre-payment just before the PMI could go away and then have a bigger emergency fund in the meantime.

    Can you guys live off of your 60K salary temporarily if your husband were to quit his job? If not, how much income would he need to bring in above your salary? Something that has always helped me to be less stressed when I was unhappy with my job was to have a large-ish emergency fund.

    If you’re not already tracking your spending, I would absolutely start. It’ll help you be more informed throughout the year and make you feel more confident about your options of your husband possibly leaving his job in the future.

    • SP Says:

      Wow, is that really how PMI works? You would think you could drop it as soon as you reach 80%, rather than waiting for a date in the future. That is annoying!

      • Leigh Says:

        I think I read an article that PMI on some mortgages after some date in 2013 or 2014 can NEVER be removed for the life of the loan. Scary! Some before that seemed to be once you reached 80% and others were on a date in the future. But $335/month PMI is expensive!

    • nicoleandmaggie Says:

      Ohhh, I read that as they were expecting to hit 80% with their regular payments in 2 years, not that the PMI won’t go away until two years from now even if they do pre-pay it. That does change things– also makes refinancing (if they’re allowed to do that) look more attractive.

      A good reason never to buy without 20% down.

    • Pondering25K Says:

      Yeah, so when we got our FHA loan we still were in the “MI goes away in 5 years” timeframe, not the new FHA loans. Too late to debate as to whether or not it was a good idea to buy our house :) Leigh is correct in that the $335/month won’t go away for another two years regardless of how much we prepay. However, if we used the 25K now, we worry about HAVING to prepay (although, we would like to if we can) to get rid of the MI after the two years. This way, we free up 800/month in prepayment now, and then 335/month in the MI in the future. Of course, we also save a lot of interest over the life of the loan.

      We can live off of my salary temporarily, as we already have a pretty big emergency fund in addition to the 25K. We would be fine for at least 6 months, but probably closer to a year. That includes the extra 800/month prepayment we would need to stay on track to lose the MI as early as possible, but not daycare.

      We track our spending using but aren’t satisfied with the information we get out of it. We have low expenditures aside from the big ticket items (mortgage, daycare(!), car payment, food), and we could definitely cut down on eating out, but we can’t seem to really find much else superfluous spending. We do contribute a lot to retirement funds and our son’s 529 each month that we could cut down if necessary.

  2. Susan Says:

    The MI is what has to go. It’s not buying you anything. The car and the mortgage are at least paying for something (for instance, that you could liquidate if need be).

    I read what the asker wrote as: they have to pay MI for 5 years at least (so 2 years more), AND if they prepay more than they’re doing now (like throw the $25 at that), they’ll land at 80% at 5 years. MI for 2 years at $335/mo is $8,040. I say refi. It shouldn’t cost $8k.

    • nicoleandmaggie Says:

      If they haven’t looked into the refinance options *after* having plowed in extra cash to bring up the P/V ratio to 20%, then they should run that exercise as well. So long as they’re under 80%, refinancing may not be a better deal.

  3. chacha1 Says:

    Wow, that’s some nasty little catch on the PMI. fwiw, for other readers, I would advise not buying a house at all if you can’t put 20% down. Look at all that money that is going NOWHERE because of the PMI requirement.

    I would advise trading in that overpriced car for something much less expensive, and paying it off immediately. Then look at what’s left of the $25K. A very good, very reliable, very efficient car can be had for $16K (or less) brand new.

    What I’m seeing is a bit of lifestyle inflation *in advance of* secure jobs, followed by immediate job dissatisfaction and some dreaminess. I’m sure I’m reading into it, but because of personal experience, I have a low tolerance for partners who propose to put their family’s financial security on the line because “I want to work for myself” or whatever. Purely my interpretation.

    A couple with a high income like this should be able to be completely debt-free (and that includes the mortgage) in a short period of time, and then they REALLY have freedom. Freedom is not freedom if it only applies for half of the couple. Take it from the one who is locked in because a much-loved spouse wanted to work for himself. Yes, he’s successful, but our financial security is 100% riding on me. It’s not a good place to be for the long term.

    • xykademiqz Says:

      high income like this should be able to be completely debt-free (and that includes the mortgage) in a short period of time

      I think this may be a bit harsh. This really depends on how solvent they were coming into this income,whether or not they have kids and how many, and whether they live in a high cost of living and/or property tax area. Saving for college and paying for daycare and are nothing to sneeze at, especially in parts of the country where public schools are good. Kids cost a ton of money in more ways than one (e.g., if you are like me and DH, you want to give them experiences and travel and summer activities while they are little, and you want to eat good quality food, etc.)

      There are also secondary considerations such as the size of the house. For instance, it is very cold an snows 6 months of the year where we are now. It’s important to us to have a big house so we don’t get stir crazy during winter; it also enables me to take advantage of faculty job flexibility if I have a good home office and can both work and do the million required summer pick-up/drop-offs. When I lived where the weather is more mellow, a much smaller dwelling is just fine because it nudges you to spend more time outside.

      • Pondering25K Says:

        Good points. We do live in a relatively high property tax area. Daycare costs are ridiculous. We could have a really nice rental property for the price of daycare (or a much lower paying job for my husband). That is part of our planning, since daycare costs will go down once he’s in preschool, and then away once he’s in school. However, daycare costs alone aren’t so big that removing them by having my husband stay at home (which he would LOVE) makes up the difference.

    • Pondering25K Says:

      My car is a Subaru, nothing crazy. Before this I did buy a “reliable” 16K brand new car (Kia), and it didn’t live up to my expectations with regards to resale value, durability, and especially safety (once we had our son).

      I don’t think our lifestyle is that inflated. We have no coffee habits, no nanny, no landscapers, etc. We do eat out more than we should (local pizza places, not 4 star restaurants), but we really don’t spend that much on stuff that could be cut out. We are pretty frugal, except regarding our house.

      My husband is 1000% not the dreamy type. He has been in his field for long enough to know that it’s not what he wants to do forever, and he’s had roles in pretty much every aspect of the field. I am not worried about having to simplify our lifestyle to accommodate his everyday satisfaction levels. In fact, I am much more wary of having one of us feeling trapped in a job because of money. I love my job, and I’m getting paid more than I was as a postdoc, so it’s really all on him because he earns so much more than me AND doesn’t enjoy it. Doing something you don’t enjoy for 9 hours a day (with a >45 min each way commute) and not being able to spend enough time with your family is not ideal long term no matter how much money you make.

      We totally agree about getting debt-free as the ultimate in freedom/flexibility. We dream about and plan for this in our free time. That’s why we are so torn on making a decision, even though we know that we are in relatively good shape regardless of what we do.

      • chacha1 Says:

        If you’re really happy with the car, then I’d say pay it off and be out from under that payment. :-) Otherwise, it sounds like you’re satisfied with your lifestyle and doing well. Congratulations!

  4. SP Says:

    I agree, getting rid of the 335/mo is a high priority – except they don’t see that benefit for two more years! Two years at a job you hate is a long time.

    I disagree with the refi suggestion – what kind of rate can they refinance into? 3.25 fixed seems attractive over 30 years, it is probably worth stomaching the stupid $335/mo until the 5 year mark. One would have to do the math to know the rate and closing costs where this would actually make sense.

    I like Leigh’s suggestion too. It would “feel” nice to get rid of the auto loan, but I don’t think it is that great of an option. Although, I question why one would have a $25k car loan in the first place, it is too late for that.

    • nicoleandmaggie Says:

      It’s not just the MI, it’s also that they can’t reamortize if they pre-pay… there’s a lot of other features to the loan that aren’t great

      3.25 is a great fixed rate, but, like Susan noted, if they have enough money to get them to an 80% loan, they may be able to lock into the same rate without the restrictions at a cost less than what they would be paying on MI during those two years. 8K is pretty steep for a refinance for a couple with good credit, a high income, and 20% down. Maybe not so steep without 20% down. I don’t know what numbers currently are, and they’re also going to vary based on the local markets and regulations. But it may be worth looking into again, especially if when they looked into refinancing before they weren’t taking into account having 20% down on the refi.

      • Pondering25K Says:

        Yeah the inability to re-amoritize is the major thing. It would be so awesome to be able to take advantage of that now, and then re-amoritize in the future so we could have a lower payment if my husband found a different job. I think that we need to call some banks and see what we could get for interest rates now and what refinancing fees would look like. Although, if we ultimately decide to downgrade our house, this would be totally silly.

      • nicoleandmaggie Says:

        Downsizing is a great way to cut required expenses!

  5. xykademiqz Says:

    According to my totally nonexpert opinion, and with the amount they are making now (assuming DH doesn’t go jobless for long or doesn’t take a drastic pay cut), they could definitely afford a better and shorter-term mortgage because what they have now is fairly low and their retirement is in good shape. We have similar income overall and three kids and our P&I on the mortgage is about $2600, plus another $700 we escrow for property taxes monthly.We have 8 years to go on a 10-year loan (we wanted to be done with mortgage bfore the time middle kid hits college). I recommend prepaying down to below 80% ASAP and then aggressively refinancing to a decent shorter term loan sans PMI. The lower rates of short-term loans and removal of PMI might end up leaving you paying per month close to what you do now for a much shorter loan, so less interest overall.

    • nicoleandmaggie Says:

      It’s interesting how the 15 year with FHA doesn’t have the 60 month MI requirement, but the 30 year one does.

      • Pondering25K Says:

        I like this line of thinking. We will definitely look into shorter term mortgages too, although I would worry about still lacking flexibility. Gotta run the numbers!!

  6. Leah Says:

    You’ve got good advice here. Given the PMI thing, I’d pay off the car right now, and then funnel that car payment into extra on the mortgage until you can work through refinancing to better terms.

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