How to think about housing/debt
November 6, 2014 7:38 AM Subscribe
Should I refinance my mortgage, cash out equity to pay off debt.
Hey, single guy here. I have a house worth about 200k. I still own 75K on it. 9 years left on a 20 year mortgage at 5.125%. 35k in pretty stupid consumer debt (getting rid of a deadbeat SO has plugged this hole in my budget). 250k in ROTH and Simple IRA. I'm about to refinance, borrowing 135k at 4% for 30 years. Pay off 75k of mortgage, and 35k in consumer debt. Taking the remaining ~25k to fill up retirement accounts. My monthly housing cost won't change, I'll save ~1k/month on debt payments which can go to other retirement opportunities. I think it is tough to "eat a house" if it is paid off and time for compounding investments is my most precious resource. I do not care about "leaving" a paid off house or estate.
Where is my error in logic? Am I about to really mess up my financial life?
Hey, single guy here. I have a house worth about 200k. I still own 75K on it. 9 years left on a 20 year mortgage at 5.125%. 35k in pretty stupid consumer debt (getting rid of a deadbeat SO has plugged this hole in my budget). 250k in ROTH and Simple IRA. I'm about to refinance, borrowing 135k at 4% for 30 years. Pay off 75k of mortgage, and 35k in consumer debt. Taking the remaining ~25k to fill up retirement accounts. My monthly housing cost won't change, I'll save ~1k/month on debt payments which can go to other retirement opportunities. I think it is tough to "eat a house" if it is paid off and time for compounding investments is my most precious resource. I do not care about "leaving" a paid off house or estate.
Where is my error in logic? Am I about to really mess up my financial life?
My concerns would be:
1.) Are your retirement accounts bringing in more than 4% per year? If not, I'm not sure it makes sense to borrow the extra 25k.
2.) Assuming your consumer debt is credit card debt: by paying off unsecured debt with secured debt you're essentially giving your house a collateral for consumer debt that you could walk away from (eating the necessary hit to your credit score).
If you're reasonably confident in your current income stream though, I'd say it's probably a decent plan. I'd really be hesitant about borrowing extra just to try and arbitrage a couple of interest points in a retirement fund though.
posted by sparklemotion at 7:45 AM on November 6, 2014 [2 favorites]
1.) Are your retirement accounts bringing in more than 4% per year? If not, I'm not sure it makes sense to borrow the extra 25k.
2.) Assuming your consumer debt is credit card debt: by paying off unsecured debt with secured debt you're essentially giving your house a collateral for consumer debt that you could walk away from (eating the necessary hit to your credit score).
If you're reasonably confident in your current income stream though, I'd say it's probably a decent plan. I'd really be hesitant about borrowing extra just to try and arbitrage a couple of interest points in a retirement fund though.
posted by sparklemotion at 7:45 AM on November 6, 2014 [2 favorites]
You shouldn't borrow more than you absolutely have to, and you should pay everything off as fast as you can. Debt sucks and without it, you can make way more interesting choices.
posted by bensherman at 7:52 AM on November 6, 2014 [3 favorites]
posted by bensherman at 7:52 AM on November 6, 2014 [3 favorites]
Echoing what others have said here, skip the 25k retirement addition and just borrow what you need to get rid of the consumer debt. I don't see a compelling reason to put borrowed money in your savings; I would refinance for 110k and either shorten the mortgage term or use the savings to supplement the 1k/mo you're planning on putting toward retirement.
posted by igowen at 8:05 AM on November 6, 2014 [5 favorites]
posted by igowen at 8:05 AM on November 6, 2014 [5 favorites]
(a) It's easy to say "my monthly payments won't change" and overlook the fact that you would be extending your payment term by 21 YEARS.
(b) You're taking on a lot of risk and locking part of your net worth into a slightly less liquid vehicle on the hopes that your investment yield will beat your loan interest rate by a few percent.
(c) Taking equity out of the house to pay off the consumer debt is almost a no-brainer provided you don't just wind up back in the same situation. The deadbeat SO may have been the proximal cause for the debt, but it's worth examining your own role in how you got to that point. Make sure that becoming suddenly free of your debt burden doesn't lead you to suddenly loosen up on whatever frugality measures you may have had in place to try to pay it down/keep it down previously. It's easy to say you'll have an extra $1,000/mo to put toward retirement and hard to not have that become extra money for a new phone or a better car or a bigger vacation. In your past, something in your psyche said it's OK to spend money I don't have, and getting rid of the debt and the deadbeat SO doesn't necessarily get to the root problem.
Practically speaking, I'd look at a 15-year loan for enough to pay off your consumer debt but no more, even if it ups your monthly payment by a bit; you should get a killer interest rate.
posted by drlith at 8:14 AM on November 6, 2014 [10 favorites]
(b) You're taking on a lot of risk and locking part of your net worth into a slightly less liquid vehicle on the hopes that your investment yield will beat your loan interest rate by a few percent.
(c) Taking equity out of the house to pay off the consumer debt is almost a no-brainer provided you don't just wind up back in the same situation. The deadbeat SO may have been the proximal cause for the debt, but it's worth examining your own role in how you got to that point. Make sure that becoming suddenly free of your debt burden doesn't lead you to suddenly loosen up on whatever frugality measures you may have had in place to try to pay it down/keep it down previously. It's easy to say you'll have an extra $1,000/mo to put toward retirement and hard to not have that become extra money for a new phone or a better car or a bigger vacation. In your past, something in your psyche said it's OK to spend money I don't have, and getting rid of the debt and the deadbeat SO doesn't necessarily get to the root problem.
Practically speaking, I'd look at a 15-year loan for enough to pay off your consumer debt but no more, even if it ups your monthly payment by a bit; you should get a killer interest rate.
posted by drlith at 8:14 AM on November 6, 2014 [10 favorites]
What the other folks said. If you're required to take out that much in order to get that loan rate, you can immediately make a payment putting the extra back toward the mortgage. Reduce your spending to fund your retirement accounts instead. (And remember that selling the house is also a way of adding more income for retirement, if there is somewhere else you could live affordably at that point.)
posted by metasarah at 8:18 AM on November 6, 2014 [1 favorite]
posted by metasarah at 8:18 AM on November 6, 2014 [1 favorite]
It's a risk but I don't think it's necessarily a crazy one, depending on how many years you have to let the tax sheltered money grow.
Are you looking to put the $25K in this year in basically one lump sum? If so, you might reconsider, as it's a weird time in the market at the moment. It could take off or there could be another big pullback and buying on the wrong day could cost you a bundle. If you're talking about next year, you could take the money in cash and put it in over a period of time to decrease your chances of a catastrophic buy (but decreasing your odds of doing really well).
posted by Candleman at 8:30 AM on November 6, 2014
Are you looking to put the $25K in this year in basically one lump sum? If so, you might reconsider, as it's a weird time in the market at the moment. It could take off or there could be another big pullback and buying on the wrong day could cost you a bundle. If you're talking about next year, you could take the money in cash and put it in over a period of time to decrease your chances of a catastrophic buy (but decreasing your odds of doing really well).
posted by Candleman at 8:30 AM on November 6, 2014
Packaging all your remaining debt into a single fixed 30 year obligation can be a way to insure against unforeseen issues like a job loss. We did that awhile back, but did it with the intent of paying off the mortgage relatively quickly. We took vehicle loans, the existing mortgage, and a few other things and refinanced for the total. I told the loan officer after it was all signed that we planned to pay it off in about three and a half years, at which point she looked a little stunned and told me that wasn't possible. We merely continued to pay off debt at the rate that we had previously been sustaining, which was substantially more than the new mortgage amount. And of course it was possible, but the math on these things can be counterintuitive. A spreadsheet and some experimentation is helpful.
With that in mind, I would point out that there's some value to be had in taking out the 30 year but paying it off at a faster rate. If you are comfortable that your retirement accounts will outperform the mortgage, then there could be value in that as well, but investments are subject to substantial variability while a mortgage would be fixed. Consider taking the 30 year but throwing your extra cash at the mortgage as extra payments for a year to shorten the term of the mortgage substantially and reduce the amount of money being paid to the lender as interest.
posted by jgreco at 8:39 AM on November 6, 2014
With that in mind, I would point out that there's some value to be had in taking out the 30 year but paying it off at a faster rate. If you are comfortable that your retirement accounts will outperform the mortgage, then there could be value in that as well, but investments are subject to substantial variability while a mortgage would be fixed. Consider taking the 30 year but throwing your extra cash at the mortgage as extra payments for a year to shorten the term of the mortgage substantially and reduce the amount of money being paid to the lender as interest.
posted by jgreco at 8:39 AM on November 6, 2014
When looking at this information, go to mortgagecalculator.org or any other online mortgage calculator to see what your different options are. For example, $135,000 at 4% is under $650 a month; and $110,000 at 4% is just over $810. But 15 year rates are a little lower, so at 3% it's $760. They also show you know how much you will pay, principal plus interest, over the life of the loan.
Also consider your rainy-day fund. There is lots of advice here on the Green showing how much you should have where it is reachable in the event of an emergency, and neither a house nor retirement savings are liquid. Paying off a 15 year loan, with the additional income from non-SO spending, could allow you to build up that rainy-day fund in any event, but be sure you include that into your calculation.
posted by China Grover at 9:02 AM on November 6, 2014 [1 favorite]
Also consider your rainy-day fund. There is lots of advice here on the Green showing how much you should have where it is reachable in the event of an emergency, and neither a house nor retirement savings are liquid. Paying off a 15 year loan, with the additional income from non-SO spending, could allow you to build up that rainy-day fund in any event, but be sure you include that into your calculation.
posted by China Grover at 9:02 AM on November 6, 2014 [1 favorite]
Regarding the $25k that has been brought up, what's your thinking? There may be some tax advantages to maxing out an IRA, but that should be less than $25k unless you've missed several years.
Ignoring tax implications, if you have some kind of balanced portfolio strategy, it would make more sense not to take the extra $25k loan at 4% and simply reduce your bond allocation by $25k, because bonds pay much less than 4%.
posted by justkevin at 9:04 AM on November 6, 2014
Ignoring tax implications, if you have some kind of balanced portfolio strategy, it would make more sense not to take the extra $25k loan at 4% and simply reduce your bond allocation by $25k, because bonds pay much less than 4%.
posted by justkevin at 9:04 AM on November 6, 2014
I wouldn't borrow money to put into retirement funds. I might refinance to pay down debt though.
I'd look to keep the payments as low as possible, and for as short a term as possible. What happens if refinance for $110,000, on a ten year term? That way your house is paid for within the same timeframe that you expected, and your payments should be relatively equal. (give or take.)
Once you've paid off your house, you can then take your mortgage payment and pump that into your retirement accounts.
posted by Ruthless Bunny at 9:07 AM on November 6, 2014
I'd look to keep the payments as low as possible, and for as short a term as possible. What happens if refinance for $110,000, on a ten year term? That way your house is paid for within the same timeframe that you expected, and your payments should be relatively equal. (give or take.)
Once you've paid off your house, you can then take your mortgage payment and pump that into your retirement accounts.
posted by Ruthless Bunny at 9:07 AM on November 6, 2014
When you borrow money to put into investment funds (which you would be doing for your retirement contribution), it's called leveraged investment. (Click on the link for why this is a bad idea.) People used to do this all the time when the stock and housing markets kept going up and up, and arguably, this is also one of the reasons that the Great Recession was so catastrophic.
posted by ethidda at 11:15 AM on November 6, 2014 [1 favorite]
posted by ethidda at 11:15 AM on November 6, 2014 [1 favorite]
As others have said, if possible, take out a shorter term loan for only as much as you need to pay off the consumer debt and refinance the current debt on the house.
Over 30 years, you typically pay more in interest than the original amount of the loan. It won't be too painful with such a low interest rate, but when interest rates are higher, the interest portion of the mortgage can add up to 2 to 3 times the original loan value. Plus, 30 years is a long time frame. It's really hard to be sure you will continue to be hail and hardy and making good money for that entire period. And, yes, you are basically now securing previously unsecured debt and using your house as collateral for it. That isn't a bad thing per se, but it is a reason to be as conservative as possible so you don't lose your house should things go wrong.
If you run into serious financial trouble for some reason, you can just stop making payments on credit cards. It destroys your credit and they may engage a law firm to try to collect, but if you simply stop making payments on your house, at some point, they evict you and take it. If you have a great deal of equity in the house, this can be a very substantial and painful loss. Many people seem to either not know how to cope with a sudden financial crisis or are reluctant to take the necessary actions quickly enough.
Do a little reading and realistically assess a catastrophic worst case scenario. If the day after you sign the new mortgage, pay off all the consumer debt, etc, you are in a catastrophic accident and can no longer work and suddenly have medical bills, are you prepared to sell your home -- possibly for a song -- as quickly as possible to limit the damage? If not, what protections do you have in place that will help put off a worst case scenario of being forced to either sell or be foreclosed upon?
Going from a 20 year mortgage with 9 years left to a 30 year mortgage in order to make consumer debt magically disappear is a neat magic trick. But it isn't really all that financially conservative, especially given the plans to borrow more than you really need in order to invest it and the addition of extra years of mortgage payments when you clearly could currently afford to raise the mortgage payment and still be money ahead by cleaning up the consumer debt mess.
I think you are making a mistake to try to keep your mortgage about the same while folding consumer debt into it at the cost of adding so many years to the mortgage. If the new mortgage payment is substantially less than the current mortgage plus consumer debt payments, you will still improve your cash flow. If you can do that without pushing your financial freedom another two decades into the future, that would be a good thing. But this current plan to make yourself more comfortable now while hanging an albatross around the neck of your future self is on somewhat shaky ground at the moment.
posted by Michele in California at 11:48 AM on November 6, 2014 [1 favorite]
Over 30 years, you typically pay more in interest than the original amount of the loan. It won't be too painful with such a low interest rate, but when interest rates are higher, the interest portion of the mortgage can add up to 2 to 3 times the original loan value. Plus, 30 years is a long time frame. It's really hard to be sure you will continue to be hail and hardy and making good money for that entire period. And, yes, you are basically now securing previously unsecured debt and using your house as collateral for it. That isn't a bad thing per se, but it is a reason to be as conservative as possible so you don't lose your house should things go wrong.
If you run into serious financial trouble for some reason, you can just stop making payments on credit cards. It destroys your credit and they may engage a law firm to try to collect, but if you simply stop making payments on your house, at some point, they evict you and take it. If you have a great deal of equity in the house, this can be a very substantial and painful loss. Many people seem to either not know how to cope with a sudden financial crisis or are reluctant to take the necessary actions quickly enough.
Do a little reading and realistically assess a catastrophic worst case scenario. If the day after you sign the new mortgage, pay off all the consumer debt, etc, you are in a catastrophic accident and can no longer work and suddenly have medical bills, are you prepared to sell your home -- possibly for a song -- as quickly as possible to limit the damage? If not, what protections do you have in place that will help put off a worst case scenario of being forced to either sell or be foreclosed upon?
Going from a 20 year mortgage with 9 years left to a 30 year mortgage in order to make consumer debt magically disappear is a neat magic trick. But it isn't really all that financially conservative, especially given the plans to borrow more than you really need in order to invest it and the addition of extra years of mortgage payments when you clearly could currently afford to raise the mortgage payment and still be money ahead by cleaning up the consumer debt mess.
I think you are making a mistake to try to keep your mortgage about the same while folding consumer debt into it at the cost of adding so many years to the mortgage. If the new mortgage payment is substantially less than the current mortgage plus consumer debt payments, you will still improve your cash flow. If you can do that without pushing your financial freedom another two decades into the future, that would be a good thing. But this current plan to make yourself more comfortable now while hanging an albatross around the neck of your future self is on somewhat shaky ground at the moment.
posted by Michele in California at 11:48 AM on November 6, 2014 [1 favorite]
Response by poster: OK, thanks for the input, I need to do more homework. My weekend will be spent with spreadsheets.
One detail is one of the retirement pots I mentioned is my ROTH IRA. I would add 5.5k at the end of 2014 and 5.5k to start 2015. I can access those funds (the principle invested) at any time (since I've already paid the tax on that). My ROTH IRA principle serves as an emergency fund.
Lastly I'm still waiting on the appraisal and underwriters. It won't be a catastrophe if it doesn't happen, I'm just trying to maximize my assets and opportunities.
posted by Classic Diner at 12:55 PM on November 6, 2014
One detail is one of the retirement pots I mentioned is my ROTH IRA. I would add 5.5k at the end of 2014 and 5.5k to start 2015. I can access those funds (the principle invested) at any time (since I've already paid the tax on that). My ROTH IRA principle serves as an emergency fund.
Lastly I'm still waiting on the appraisal and underwriters. It won't be a catastrophe if it doesn't happen, I'm just trying to maximize my assets and opportunities.
posted by Classic Diner at 12:55 PM on November 6, 2014
My ROTH IRA principle serves as an emergency fund.
Great, wonderful and fantastic. BUT, if something goes really crazy wonky in the world and your ROTH IRA is suddenly essentially worthless, you are still on the hook for the mortgage. Unlike a bank account, investments are not guaranteed or protected. There is a potential upside because there is a potential downside. That is the inherent nature of investment.
Borrowing to invest is less dumb than borrowing to piss it away on fancy vacations and the like, but when it is done in a way that erodes your current stability and starts veering into something akin to gambling, that sometimes really bites people in the arse.
The expectation that because you are currently in good financial shape, the world must be pretty financially stable and you can bet on the big picture remaining roughly the same is kind of foolish. We are having a drought in the West that has people talking about the possibility of water wars and we are coming up on Peak Oil which is likely to undermine the current global economy by yanking our current relatively cheap sources of energy out from under us. In short, lots of rich folks jumped out of windows when the stock market tanked in 1929.
Will you jump out of a window if things go to hell on this and your ROTH is worthless and you still owe the debt with which you financed it? If it were me, I would want to be carrying as little debt as possible (in fact, I am currently paying down debt while not running up new debt). Investments can disappear over night. Owning your house outright where all it costs you is taxes, insurance and maintenance is a form of security that, in real terms beats any retirement fund hands down. Takings law is very conservative. The American government is pretty good about respecting the idea that your house is your castle. So if you want security, that's a better way to bet. It will probably only go to hell if the American government fails and becomes dissolved as a nation or is taken over by another sovereign nation. This seems reasonably unlikely to happen in my lifetime. But some particular investment instrument turning sour overnight -- that totally has happened in my lifetime and will no doubt again.
Best of luck.
posted by Michele in California at 1:17 PM on November 6, 2014
Great, wonderful and fantastic. BUT, if something goes really crazy wonky in the world and your ROTH IRA is suddenly essentially worthless, you are still on the hook for the mortgage. Unlike a bank account, investments are not guaranteed or protected. There is a potential upside because there is a potential downside. That is the inherent nature of investment.
Borrowing to invest is less dumb than borrowing to piss it away on fancy vacations and the like, but when it is done in a way that erodes your current stability and starts veering into something akin to gambling, that sometimes really bites people in the arse.
The expectation that because you are currently in good financial shape, the world must be pretty financially stable and you can bet on the big picture remaining roughly the same is kind of foolish. We are having a drought in the West that has people talking about the possibility of water wars and we are coming up on Peak Oil which is likely to undermine the current global economy by yanking our current relatively cheap sources of energy out from under us. In short, lots of rich folks jumped out of windows when the stock market tanked in 1929.
Will you jump out of a window if things go to hell on this and your ROTH is worthless and you still owe the debt with which you financed it? If it were me, I would want to be carrying as little debt as possible (in fact, I am currently paying down debt while not running up new debt). Investments can disappear over night. Owning your house outright where all it costs you is taxes, insurance and maintenance is a form of security that, in real terms beats any retirement fund hands down. Takings law is very conservative. The American government is pretty good about respecting the idea that your house is your castle. So if you want security, that's a better way to bet. It will probably only go to hell if the American government fails and becomes dissolved as a nation or is taken over by another sovereign nation. This seems reasonably unlikely to happen in my lifetime. But some particular investment instrument turning sour overnight -- that totally has happened in my lifetime and will no doubt again.
Best of luck.
posted by Michele in California at 1:17 PM on November 6, 2014
I'm not recommending this but I could see adding the 5.5k to the Roth IRA for 2014 since that is an opportunity that will disappear (although I think you have until April 2015). But I would suggest that you really want to set up your budget so that you are putting enough money into your retirement on a regular, on-going basis to cover your annual contribution. Once that becomes part of your spending/savings habit it will put you in a better position to continue making the contributions year after year. If you really want to support your own long-term financial health, you will want to be saving more than the IRS contribution limits but that is another conversation.
posted by metahawk at 3:17 PM on November 6, 2014 [1 favorite]
posted by metahawk at 3:17 PM on November 6, 2014 [1 favorite]
This thread is closed to new comments.
posted by jon1270 at 7:44 AM on November 6, 2014 [9 favorites]