Pay off debt or save?

[Gardner Barnes]

This is the age old question. Here is my situation:

House Appraised at 600,000
Mortgage balance 121,000 at 4.75 fixed
HELOC balance at 75,000 at 4.00 (variable prime -0.5 with a 4.00 floor)
Student Loan balance at 31,000 at 2.25% fixed

no other debt (we use an Amex, pay in full, own both cars etc)

Adequate savings of approx 70,000 in cash
typical Retirement savings, kids college etc

I am about to receive a $63,000 bonus and my question is this:
Should I combine the bonus and savings and pay of the 1st mortgage, pay of the HELOC, or pay off the student loan and pay down the HELOC? Should I just bank the cash? The rates on our debt is pretty low.

One issue to consider is that I do not receive any tax benefits for the student loan because I make too much money.

[jIM_Ohio]

what do retirement accounts look like,

how much
what type of account

how old are you
when do you plan to retire
what are annual expenses (current)
how do you project those expenses into retirement (same, different, higher, lower)?

[bjl584]

A lot of people here will tell you to do a little of both. But, as Jim said, you will need to post more info.

[snshijuptr]

Is your HELOC tax deductible? Your after taxes interest on the first mortgage may be less depending on your tax bracket and deductions.

I'm all about maxing out the rewards. So if you can guarantee higher returns by saving the money then do that. Otherwise pay down debt and feel great about it! Considering that you have children, I recommend keeping your emergency fund intact.

[cschin4]

I guess I don't live in a world of $600K homes! But, I think you should pay off the HELOC since variable rates are always worrisome if you ask me.

[johnins2009]

What I say is "how can you save if you have debt?" Now granted some debts can't be paid off really fast like a mortgage but you have to think about it. If you have debt, you're paying interest on those debts. Why not pay off your debt, then you will have MORE to save.

[isralexba]

in theory you should almost always pay debt instead of saving, as you are paying for your debt a lot more than what you get on your savings.

[Homebody]

I would personally bank it and then get very aggressive about HELOC, then student loan. Are you staying house forever?

[disneysteve]

Adequate savings of approx 70,000 in cash
typical Retirement savings, kids college etc

Not enough info to answer your question.

How much do you earn?
What percentage of income is currently going to savings?
I have no idea what "typical retirement savings, kids college, etc" means. I would say that college savings should probably be zero at this point in your life. What sense does it make to be saving for your kid's college when you haven't paid off your own college yet?

Let's see your numbers and then we can answer your question.

[Gardner Barnes]

Sorry for just now getting back to this. Here is some additional data:

I will receive the bonus on or around 4/1.

Age 36
Income is variable (sales), but ranges from 150,000 to 250,000.
2 kids, 5 and 3

I save about 18-20% of my yearly income in mostly retirement accounts. This does not include the 529s

I plan to stay in the house forever - but as we know, forever changes rapidly.

I have not thought about when I am going to retire, Maybe 60?

I am waiting for another offer from a new employer and plan to leave my current employer at that time. I expect that to happen on or around 4/1 but it may be later because employer #2 is in the process of closing out the quarter and that tends to delay decision making.


Retirement (as of this AM)
313,000 in 401K and IRAs, and a cash value pension that is no long being contributed to by my employer and just gains interest at the rate of about 2% per year. When I leave my employer I can roll it over into an IRA


College Savings 529s
Kid 1 (5) 21,000 (+ 5K/year)
Kid 2 (2) 13,000 (+5K/year)

The HELOC is tax deductible

Our monthly coses run about 5000-6000 depending on the month (i.e. higher when preschool is in session, or the months when car insurance is due, for example)

Property taxes in my state are high so we have a separate account to avoid escrow $13,000

We own 2 late model cars so I don't anticipate those needing to be replaced for 5 years.

[jIM_Ohio]

This is the age old question. Here is my situation:

House Appraised at 600,000
Mortgage balance 121,000 at 4.75 fixed
HELOC balance at 75,000 at 4.00 (variable prime -0.5 with a 4.00 floor)
Student Loan balance at 31,000 at 2.25% fixed

no other debt (we use an Amex, pay in full, own both cars etc)

Adequate savings of approx 70,000 in cash
typical Retirement savings, kids college etc

I am about to receive a $63,000 bonus and my question is this:
Should I combine the bonus and savings and pay of the 1st mortgage, pay of the HELOC, or pay off the student loan and pay down the HELOC? Should I just bank the cash? The rates on our debt is pretty low.

One issue to consider is that I do not receive any tax benefits for the student loan because I make too much money.

I copied above from OP.

Sorry for just now getting back to this. Here is some additional data:

I will receive the bonus on or around 4/1.

Age 36
Income is variable (sales), but ranges from 150,000 to 250,000.
2 kids, 5 and 3

I save about 18-20% of my yearly income in mostly retirement accounts. This does not include the 529s

I plan to stay in the house forever - but as we know, forever changes rapidly.

I have not thought about when I am going to retire, Maybe 60?

I am waiting for another offer from a new employer and plan to leave my current employer at that time. I expect that to happen on or around 4/1 but it may be later because employer #2 is in the process of closing out the quarter and that tends to delay decision making.


Retirement (as of this AM)
313,000 in 401K and IRAs, and a cash value pension that is no long being contributed to by my employer and just gains interest at the rate of about 2% per year. When I leave my employer I can roll it over into an IRA


College Savings 529s
Kid 1 (5) 21,000 (+ 5K/year)
Kid 2 (2) 13,000 (+5K/year)

The HELOC is tax deductible

Our monthly coses run about 5000-6000 depending on the month (i.e. higher when preschool is in session, or the months when car insurance is due, for example)

Property taxes in my state are high so we have a separate account to avoid escrow $13,000

We own 2 late model cars so I don't anticipate those needing to be replaced for 5 years.

the question

Should I combine the bonus and savings and pay of the 1st mortgage, pay of the HELOC, or pay off the student loan and pay down the HELOC? Should I just bank the cash? The rates on our debt is pretty low.

I would use the bonus to stablize yourself financially. I do not think you are unstable now, but do think you could do better, so here is what I suggest:

1) Because you are in sales with a volatile income (100k fluctuation year over year is volatile to me when its 40% of your income), I would suggest putting 1 years expenses, in CASH in CDs, money market accounts or similar cash based investments.

You have 70k in cash listed above- so you meet this, but read on...


2) Put another 1 years expenses in something close to cash. Because monthly spending fluctuates with car insurance (see item 3), and income fluctuates (see item 1), I would add another 1 year expenses (60k) to a taxable (liquid) investment. Think moderate mutual fund- I might suggest PRPFX (I use this myself), RPSIX (I use this myself) a muni bond fund, or something which comes close to the 4% your mortgage interest is costing you. You would like this to return more than 4%, but conservative risk is more important than return, as long as the return is better than the cash.


If you do items 1 and 2, regardless of what happens financially (bad year, lose job) I can guarantee you can meet the needs of the budget outlined in #3.


3) Create a better budget which is stable month over month. Seeing a budget change $1000 per month, which is 20% of your expenses, is not stable (IMO).

Create budget by listing items with a frequency in the budget like this:


Mortgage 12 $1000 $12,000 $1000

the first number 12 is the frequency
the second number $1000 is the cost per bill
the $12,000 is your annual cost
The last $1000 is the COST PER MONTH

try that with gas

52 $75 $3900 $325

Meaning you need to budget $325 per month for gas (assuming you get paid monthly)

try that with insurance

$750 2 $1500 $125
meaning if you set aside $125/mo, when insurance bill comes you have enough money to pay it, without monthly budget going $750 higher that one month...


try that with kids school tuition...

9 $400 $3600 $300
set aside $300/mo every month and when tuition comes you do not see expenses shoot up or drop down when bill comes.

Once you set up the $120,000 in items 1 and 2, use the remaining amounts as a buffer until you have this system set up. Meaning because tuition might be due each month thru June, and I am suggesting you budget less than monthly bill, you won't be ahead until the summer (I think) so use the bonus to implement this (you might need to tap into savings until this system sets itself up).

[Gardner Barnes]

BRILLIANT!!!!

Thank you. That is EXACTLY the info I was looking for. I was pretty sure that because my income fluctuates so wildly year to year that we need more of a "cushion". That is why I was originally looking at paying off debt, but I think your savings and budgeting advise are much better.

Question: do you spread your savings vehicle #2 into several income/bond/low risk funds or do you just use PRPFX and RPSIX in a 50/50 split?

[jIM_Ohio]

BRILLIANT!!!!

Thank you. That is EXACTLY the info I was looking for. I was pretty sure that because my income fluctuates so wildly year to year that we need more of a "cushion". That is why I was originally looking at paying off debt, but I think your savings and budgeting advise are much better.

Question: do you spread your savings vehicle #2 into several income/bond/low risk funds or do you just use PRPFX and RPSIX in a 50/50 split?

PRPFX is what I hold in taxable accounts
RPSIX is my bond fund in my IRAs

I do NOT use both for the same purpose.


I mention both to make you think about what is MODERATE risk for you. What is moderate for me (PRPFX) holds 25% in gold- so if gold tanks, you better believe that cushion is going to shrink... PRPFX also holds a high amount of equities (been a while since I checked in xray, but best guess is it holds 40%+ in equities).

RPSIX is a much simpler fund- it holds stocks and bonds, mostly domestic stocks (about 15-20%) and domestic and foreign, corporate and junk bonds (80%).

If you want another suggestion, look at Wellesley.

I would use one fund for this purpose, and just choose what you define as moderate risk. Your goal is a decent return without much volatility.


I side on decent return- so I choose PRPFX
however if I wanted less volatilty I would do something like RPSIX, however because of my tax situation, I would use muni bonds and not RPSIX in a taxable account.

I know little about the 300-400k you have invested for retirement... how much do you know about what your retirement accounts hold?
How much do you know about your tax forms and tax situation year over year (with an income of 250k, muni bonds or PRPFX might be a decent idea). RPSIX in a taxable account with an income of 250k would possibly have you mumble my name with 4 letter words on April 15...

Use the 120k cushion I am suggesting as a way to make more money (4% of 120k is $4800 per year), and that money can be used for things (like vacations, tuition or other).

I would focus on the budgeting aspect of my solution first, then find an investment you like with the 120k- 60k cash and 60k in something close to cash- might be a bond ladder, moderate mutual fund, or something else. Focus on liquidity (you don't want to use 40k of this to flip houses or invest in rare art), but it is possible when market tanks next time (tank is a 30% drop) you decide to take 30k of the cash and put it into market to get a higher return for a short amount of time. You still have 1.5 years expenses in cash or close to it if you do this... so the "timing" of the tank is you expect to pull money out in 18 months...

and back to focus on budgeting... if you budget right, you might free up $100/mo or so which can be added to that item 2 choice...

meaning when you average all expenses out over 12 months, you have $100/mo extra to invest...
so you add to whichever investment you choose, and if you need money, the first thing you do is stop the $100/mo or whatever it is to the investment. For example maybe car insurance goes up, property taxes go up, or something like that, take that $100/mo and throw it at problem instead of investment.

Its possible you would prefer that $100/mo go to debt reduction... so once you have budget system set up, you can put excess monthly surplus or bonuses to debt reduction... what you were missing initially was how big a cushion you want. I am not in sales, but know salesman... their income can fluctuate with the economy, so you need to decide how long a storm you need to weather (I am suggesting 120k which is about 2 years expenses for you). If you sell space shuttles, its possible a 5 or 10 year cushion is more appropriate. Know your business cycles and plan for worst case.