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.
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?