Help a reader out

Got this letter from a fellow PDITF reader….

My husband and I own a condo in the SF Bay Area. We bought a 1bd condo at what (we thought) was the bottom of the market (sad face). We’re currently under water on the place about $30-$40K. We recently started snowballing our debt and the only remaining debt is about $3k of student loans due to be paid off in the next 2 months or so. Here’s our dilemma: after building 6 mo. of expenses in savings, should we:

1) start paying off the condo? Keeping with our current snowball amount ($3k) we could have the joint paid off in 2016! Problem is, we also plan on having children in the next few years and the maximum time we’ll live here is about 4 more years (although we’re open to using as a rental property), but we will likely stay in the area.

OR

2) start saving the 3k/investing the 3k? We are embarrassingly naive about investing in general and have no stocks/bonds/MM accounts other than our 401K…

We just don’t want to pour money into a house when we know it’s not our long term home, but we also want to make a savvy financial decision.

Advice from you/your readers would be hugely appreciated! Many, many thanks!

Courtney

The first thing that stood out to me about Courtney’s letter was this: “We are embarrassingly naive about investing in general and have no stocks/bonds/MM accounts other than our 401K”. Girl, it’s time to get educated and start investing. You need to have, at minimum, a basic understanding of the different investment vehicles available to you. That way YOU can decide if you’d rather invest or pay down the mortgage. You can’t make a decision until you know what all your options are.

I’m a fan of Vanguard mutual funds. Some love bonds. Others invest in individual stocks. I’d recommend scowering some PF blogs that really dive in to the ‘meat and potatoes’ of investing, so you and your hubby can choose the plan that’s best for you.

How much should you be investing? The general rule is at least 10% of your gross income, but probably some where closer to 15% if possible. I don’t know how much of your gross income is going in to your 401k plans, but if you’re investing less than 10%, I’d say your first plan of action (once your free of the student loan) should be to up your retirement contributions.

Unfortunately, I can’t really tell you what you should do with your discretionary income (save or pay down mortgage), because I have no clue what the real estate market in S.F. will look like in four years. If you think the markets are going up, up, up…it makes sense to pay down the mortgage a bit and let your equity appreciate. If you think the market is going down, down, down…it’s probably better to put your cash in the bank so it doesn’t lose value.

It doesn’t really sound like you are too sure what your life is going to look like 2-5 years from now. You may have a kid (you might not), your condo might go up in value (it might not), you might rent out your place (you might not). Until you really have a solid idea when you’ll be moving and when you’ll be having kids, I’d recommend putting your discretionary income in the bank. Cash gives you flexibility. If at any point down the road you decide you’d rather pay down your mortgage, you can always pull cash from your savings to do so.

I’m just one man though, and I’m definitely no real estate (or investing) expert. Let’s see what other PDITF readers would recommend doing in your situation. How bout it y’all, what do you think Courtney should do? Pay down the mortgage or build up cash savings?

25 thoughts on “Help a reader out

  1. What is the interest rate on your note? Can you beat that with a savings account? How about a bond? Equities are too risky if you only have 4 years to invest. Are you up to the task of being a landlord? Could getting a HELOC or home equity loan on your condo be used to purchase a bigger home? If you answer these questions you’ll be closer to your answer of what you should do with your surplus cash.

    I noticed how excited you got when you said you can pay off your condo by 2016. Yet you then say that you are reluctant to pour money into a home that will not be your future residence. This tells me that you should pay off the condo and rent it out. With the equity and income of the rental condo, you should have an easier time qualifying for a new home. Please make sure to learn about being a landlord or use a licensed property manager, however.

  2. We have a house that is worth less than we paid for it and we plan on having it paid for by the time we sell it in a few years. If you can pay it off in 5 years that’s pretty awesome for a place in the Bay Area. I also thought I was only going to live in my current city for 2-5 years and I’m still here 14 years later. The future is often hard to predict.

    I’d do a little of both to balance your risk. Save a little, pay down mortgage a little. That way if stocks go up, you feel like you don’t miss the boat. If stocks go down, you don’t feel like you made the wrong decision because you did actually increase your net worth by adding equity to your home. 4 years is a pretty short time horizon and who knows what’s going to happen with the market in that time.

  3. I agree with FGA… future’s very hard to predict, and I like the idea of balancing the risk. After 8 years of marriage, we’ve established ourselves in terms of decision on having children (nope), and now that there’s extra $ coming in thanks to Hubby’s OT, we’re in a position to aggressively pay off credit card debt in the New Year. We might even try putting a little extra $ towards the principle of our mortgage; 5K/year will have our place paid off in 5 years! But then there are times I think we should take that extra 5K/year and put it towards super-aggressively paying down our debt… so many options…

    We already contribute to our company’s pension plans and RSP’s, and we have our own RSP’s as well (glad we took the steps early to plan for retirement).

  4. Offhand, I’d say that if you’re not going to keep the place, pay the minimum on the mortgage so as not to damage your FICO score. Real estate goes up and down just like anything else, but it has to be seen in light of the entire financial situation. If they’re relatively young, they should probably invest agressively in stock index funds with a small proportion of bonds, But there’s too little information here, really, for me to do much more than guess at an answer. We don’t know the OP’s age, income, the purchase price of the condo, mortgage rate, what’s offered in the 401(k), how much they’re contributing, etc. Courtney could register at http://www.bogleheads.org and ask these questions, and they provide a format where all the necessary information is provided for the posters there to evaluate.

  5. Is there PMI on the condo? If there is, I would aggressively pay down until the PMI is gone.

    Ideally, I would do a 50/50 split. Invest half, put half towards the mortgage.

  6. I don’t know what to recommend about where to put your money, but I know back when I was trying to learn more about finance I found the little “classes” (they are just basic articles) offered by Morningstar to be really helpful learning about stocks/bonds/general portfolio stuff. It gave me so much more confidence when handling our finances. Good luck.

    http://www.morningstar.com/cover/classroom.html

  7. If you are upside down when you sell, you will owe money at the house closing. If you are not upside down when you sell, you will get cash at your condo’s closing, and can use that cash for the next house. Never understood why it is wasting money to pay extra to a mortgage even if the house is upside down…as long as you are not planning on “walking away,” paying off more of the money owed means less money you need to show up with at the closing.

    I disagree with investing aggressively in the stock market….it’s a four year time span, not long enough that if things go south in 3 years, they will be okay. Do you already have money saved up and/or a plan to save money for the down payment on your next house?

    I agree with others, do a 50/50 split. Half pay off your mortgage (you’ll still get the thrill of seeing that amount owed drop drop drop) and half in investments…after you learn a little more about what you want to invest in. You probably need to save that other half for the down payment for the next house.

  8. If you’re paying PMI, pay 100% towards that until PMI is gone (which I assume you are paying that because you are underwater). Once you hit that point, 100% invest.

    On a side note, 1 BR condos are horrible investments. Even in a good market, the only people who want to live in a 1 BR condo are young people with no money, or old people with no money. Next time you make a big purchase like a home, you may want to do a bit more research on what you are buying.

    • I don’t know why you are saying that. I’m a single older person with a fair amount of money, and when I bought my 1 BR condo (or technically speaking, a coop apartment) 20 years ago, I considered it a very good investment. It allowed me to buy into a good living situation at far less cost than a detached house and with full tax benefits. My mortgage payments are minimal, will be gone by the time I retire or shortly after, and although there’s a maintenance charge I’ll always have that is my largest monthly expense, I pay far less in housing expenses than I would if I were renting the identical unit.

      I don’t get the objections to investing in stocks mentioned by some others here either. If Courtney + hubby are young and they have the money, this is the best time to invest aggressively, as they have the greatest time horizon on their side. But again, too many aspects of the financial picture are vague to know what’s going on.

      • I think the main reason to avoid investing in stocks is that their short term goal is to purchase a larger home. Money in equities usually should remain for the long term. They do contribute towards their 401k, although it would be nice if they got a Roth IRA up and running too. Like you said, there is not enough info to make a good suggestion. For instance, I just calculated that to pay off the condo in 6 years at 3k extra a month, they owe more than 216k on it. I think that they should do a Roth IRA in conjunction with paying down the note now, instead of my previous suggestion of just paying off the condo. They really should hit the Bogleheads forum to get a better idea on what to do.

        • True. If they are contributing 10-15% to the 401(k), they may be saving adequately. But we don’t know how much they’re contributing, whether they’re being matched, or what their investment choices are. (As a side note, I recently sat in on a meeting of our company’s 401(k) committee. I was amazed that 40% of the participants, some in their 30s, are only in the money market fund, which is earning .05% with an expense ratio of .05%. Others shrugged this off, as if to say “it’s their money,” which is of course true, but I cringed.)

      • The other issue with 1BR condos is that when they don’t sell by their original owner, they frequently become rentals – which can turn a owner-occupied building that fits conventional mortgage guidelines into a predominantly rental building and buyers cannot get traditional financing for mortgages. I’ve got three friends who are “Stuck” being landlords because their buildings became too rented out to meet Fannie Mae’s underwriting standards due to the glut in the market of 1-2BR condos.

  9. due to her short time frame and lack of knowledge, investing is a poor idea in my opinion.

    she should treat the negative equity in her condo like debt to pay off as part of her snowball. to say that she shouldn’t pay down the house if she thinks it will go down in value is foolish–unless she is heading towards a foreclosure and bankruptcy. remember the liability against it (mortgage) stays the same. until she gets above water on her house, she can’t move, and her options are severely restricted.

    if she wont’ do that, how about a compromise? instead of paying down the condo debt, she could open a MM acount and earmark it for “condo”. if she wants to move, she can dump the MM fund on the mortgage to get back above water. if the home appreciates a lot, she can use the MM fund for other stuff. she has options this way.

    i also suggest she stop doing any retirement investing temporarily. even if that means losing an employer match. she has a mess on her hands and needs to get it cleaned up.

  10. There are two reasons snowballing the mortgage makes more sense to me.
    1. She’s upside down. This will be a problem on selling the condo. Short can be a pain so you’re better off getting the mortgage paid down.
    2. She’s considering the possibility of keeping the condo and renting it out. This is even more reason to pay the place off. With rentals there are always vacancies to deal with. It’s better not to have to cover a mortgage payment for the month or two between tenants.

    • But what about the fact that the condo is so illiquid? If she has kids wouldn’t she want some cash that’s easier to access?

  11. I don’t understand why people are assuming that the investment short term – she wouldn’t loot her investment account just because she popped out a baby. I doubt she’s putting 15% in her 401k – due to inflexibility it’s not recommended to put in more than the match, if there is one (fed gov’t is pretty agressive at 5%, making only 10% total). Investing sounds better too because it’s more illiquid than the condo – if a crises came, she’d loot her EF, then investments, and then sell the condo.

    CB – $30k of depreciation isn’t a mess. And even if so, she is she can sock her former student-loan payments; there’s no need to stop paying into a 401K and especially if there’s a match. Ridiculi all around.

    • We are assuming her savings are short term because she only wants to live in the condo for 4 years and then buy a new place….and has no mention of where her down payment for the new place is coming from (obviously not from the equity from her current place). So, in 4 years “maximum” as per her plans, she would have to loot probably the entire investment if it is for the down payment (regardless of if there is a baby).

  12. It’s purely my opinion, but I would do the following:

    1) Save for, or take your current emergency func (at least 6 months income) and put it in a FDIC Insured Money Market account with a bank like Everbank or Ally. If you have cash sitting under your mattress you’re not getting a return on it, and if your place burns down you’re in trouble.

    2) Continue to get contribute enough to get any employer retirement match.

    3) Use your current 4 year horizon to estimate what it would take to get above board on your mortgage using a tool like the one below to give you an idea. Knowlege is power.

    http://www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx

    3a) Try to add a little to your money market each month to get ready for having children, next condo, etc..

    Conclusion: The market is a good place to be long term, but there no guarantees on the short end. Money markets can be FDIC insured and give you some (read: small) return, but it’s better than nothing. Everbank is currently 1.3%. They can be viewed as a savings account with a few more rules, but doesn’t tie your funds up for years or penalize you for taking it all out. Your mortgage is a debt that needs to be paid, and should be treated as such. One would hope home prices rise where you’re at, as it is some of the most desirable real estate in the country. I think if you waited, it’s possible you could get above water faster than you think through slightly larger mortgage payments and the housing market slowly coming back.

    Lastly and most importantly, educate yourself like Ninja said with the free information available on the net. No one is going to know your situation like you do. That understanding coupled with financial knowledge will empower your family to get where you want.

    Best of luck.

    Frugal Midwest

  13. Pay down the condo. Why? Because you own it and agreed to that loan. Let’s take a look at some scenarios:

    1. You don’t pay it down:
    Condo price goes up = You might make a profit after closing costs.
    Condo price goes down (you sell at a loss) = You still owe the bank that money!
    You don’t sell = You pay more interest cost over time.

    2. You pay it down:
    Condo price goes up = You might make more overall profit after closing costs (due to less interest cost)
    Condo price goes down (you sell at a loss) = You owe the bank less money.
    You don’t sell = You pay less interest cost.

    One caveat: If you have any unused matching programs for investing at work, max them out! They are free money.

  14. Dang guys – thanks for all the advice! Too nice!

    Couple clarifications/answers:

    – Y’all are right! We definitely need to educate ourselves more about the investing options. We’ve got a great starting point thanks to NINJA (and the PF blogger movement), and rest assured we’re on it!

    – I bought the condo as a (naive) single girl who had no idea she’d fall in love and get married in 18 months. 🙂 If I could do it again, I’d totally have just sucked it up and lived with my parents a bit longer and saved for a real house! I bought it for 1/2 of what it sold for in 2006, and (yes) foolishly got in too early on something that could be potentially difficult to unload. Even so, with a 5% interest rate, my mortgage is ~$50 more than I would pay in rent for a unit in our condo complex.

    – The $30-$40K estimate is an average of what the last remaining short sales/foreclosures in the complex have sold for. There was a wave, but it definitely seems to be abating. The last regular sale unit sold for about ~15K less than what we owe – we just wanted to plan for the worst.

    Our ultimate goal is to be mortgage free before I’m 40 (13 years), hence the allure of paying off our current place. As many of you said, we have no idea if we’ll be blessed with children according to our planned schedule, so our 4 year estimate could easily shift. We do love the place and if not for the spacial constraints would stay forever!

    The rent to buy cost ratio in our town is fairly close for condos, but HUGE for SFRs. Even so, we’d love to settle here, just want to make sure we’re investing our income the best way possible in order to set ourselves up for success down the road (part of which, for us, is owning a home).

    Based on all the awesome recommendations, here’s our plan of action:
    1a) Pay down the principle until we can bid the PMI adieu!
    1b) Read, read, read. Learn, learn, learn.
    2) Go with the 1/2 and 1/2 plan. Hopefully (!) our salaries continue to grow and we can make larger and larger payments on both accounts as time goes on.

    We can’t say thank you enough and would welcome any other feedback!!!
    Courtney+Hubbs

    • This sounds like a great plan. You have done a great job getting out of debt. What about setting a small amount ($50-$100 a month) aside for a fun fund? You can use this fund to go all out on something like an anniversary dinner or an awesome vacation (especially before little ones start arriving).

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