financial gurus, advice please!

[jodi]

Hey everyone - I want to ask for advice for a family member who has been asking for my opinion. Here's the details:
Recently separated (although not legally), has a $34k mortgage at about 11% due to some really bad credit in the past. Credit has been clean for about 6 months - possibly enough to refinance based on one call to a lender, but w're not certain yet. Owns a 2000 car with no payments. Has a decent retirement package (she's a teacher), but no IRAs. Has no debt other than the mortgage plus a small line of credit at an appliance store (about $250) which will be paid off soon. She would like to do some renovations to the house, which needs the work, before looking to sell it in app. 5-10 years. She has rheumatoid arthritis and needs to get in a one-level living situation. She also has $5k in a CD which will mature in July.

She will be receiving a gift of $12,000 from a relative. What should it go for? I'm thinking establish an EF first or about $5k, then maybe put the rest toward the mortgage, since no other investments can reliably earn an 11% rate of return. Safety is a big issue, so she won't consider any risky investments. Retirement is a low concern for her, since she will be earning a good pension in addition to SS (minimum 5 years until retirement).

We would love to hear any ideas or anything we haven't thought of yet

[kv968]

Although the interest rate on the mortgage is high, the thing that stuck out to me is that she's separated. If there's a possiblity of a divorce, why would she want to pay down the mortgage? Assuming, if they did get divorced, that the equity in the house would be split equally, paying more into the house wouldn't help her in the long run. If that's the case, I think she'd be better off putting it into an EF like you suggested in case things get rocky.

[Scanner]

Well, one thing you can learn from us "gurus" is that we are not always "gurus."

I feel bad - in the other thread, we are kind of leading the readers to beleive that if you pay down a mortgage, that you get an immediate no risk return = to the APR of the mortgage.

Not entirely true although at the beginning part of the mortgage it's a good rule of thumb. It depends where you are at on the amortization schedule. With a balance of 34K on a mortgage, it sounds like she is in the last half of it in which probably means she is paying mostly principal at this time. So, there won't be an 11% return. It may only be like 2 or 3%. In that, she should just probably keep everything where it's at. In fact, in may not even make sense to refinance and start a new amortization schedule, even if the interest rate is 7 or 6%. Just hold steady and retire the debt when they sell the house or it just gets finished.

Second, and this is the intangible - she may be entering into a divorce. She is going to want to keep cash on hand. My assistant is going through a messy divorce now and her lawyer and his lawyer wanted a 4K retainer fee just to start. By the time everything is done, I'm sure the divorce will cost 15-20K total.

In short, I'd put the 12K in something conservative at this time - a munibond fund or just a vanilla savings account until there is reconcilation or divorce.

[disneysteve]

I agree with the 2 previous posters. She needs to sit tight until her divorce is final and she sees where she ends up at that point. That money might be needed to get through the process. A high yield money market sounds like a good parking spot for now. A CD is okay too, but as Scanner pointed out, she may need some of that money for legal fees so better to keep it accessible.

Originally Posted by jodi

Safety is a big issue, so she won't consider any risky investments.

I wanted to comment on this because we hear it frequently. ALL investments have risk. When most people talk about risk, they are referring to market risk, the chance that your principal could lose value by stock prices falling below your purchase price. There is also inflation risk, the chance that your conservative investments may not actually earn anything, or may even lose value, when taxes and inflation are factored in. Let's say you invest $10,000 at 5%. If you are in the 25% tax bracket, your after-tax return is 3.75%. If inflation is at 3%, your real rate of return on that investment is a measly 0.75%. Compare that to a well-balanced diversified portfolio that returns 8%, nothing too aggressive there. Now your after-tax return is 6% and your return after inflation is 3%, so you experience some measurable degree of growth.

[sweeps]

Another reason why paying the mortgage is not always the best move... loss of liquidity.

[safari]

Originally Posted by Scanner

It depends where you are at on the amortization schedule. With a balance of 34K on a mortgage, it sounds like she is in the last half of it in which probably means she is paying mostly principal at this time. So, there won't be an 11% return. It may only be like 2 or 3%. In that, she should just probably keep everything where it's at. In fact, in may not even make sense to refinance and start a new amortization schedule, even if the interest rate is 7 or 6%. Just hold steady and retire the debt when they sell the house or it just gets finished.

This is a misconception. You're always paying the same interest rate on your mortgage, whether you're in the 1st year or 20th year of your amortization schedule. The interest is calculated based on the remaining balance. So in the beginning when you have a larger balance, the interest payment comprises the bulk of your monthly payment, and as your balance gets smaller over the years, the bigger part of your monthly payment is going toward the principal. However, you're still paying 11% interest.

[jodi]

Thanks - I knew we'd get some angles that we hadn't considered, such as divorce costs. As far as maintaining her standard of living on her own, that's no problem. She supported her husband for most of the past 10 years after he stopped working due to a heart attack.
As far as divorce, she is content to remain separated in fact and not in law, although we have been discussing this a lot with her. She will be due to come into a large amount of money, probably anytime within the next few years, and our understanding is that if they are still married, half could go to him (we've encouraged lawyer involvement here). It looks like they will be going the separation/divorce route.
I would imagine that there is not a huge amount of equity in the house. I don't know if the husband would try to get any equity from it if they did divorce - he just walked out. Of course, you never know what anyone will do when there is money on the table.
As far as the mortgage goes, I know she paid over $4k in interest last year, which is just ridiculous based on the size of the mortgage (I may not have the exact rate, I 'm guessing, but I know it's high). I did her taxes for her and I had her interest statement. I see that as money that is being thrown away each month, which is why I thought it might be worthwhile to look into refinancing since she will be there at least 5 more years.
I would love to hear more thoughts as well. Definitely keeping some money liquid in a high interest bearing account is probably the best idea.

[Broken Arrow]

Originally Posted by disneysteve

I agree with the 2 previous posters. She needs to sit tight until her divorce is final and she sees where she ends up at that point. That money might be needed to get through the process. A high yield money market sounds like a good parking spot for now. A CD is okay too, but as Scanner pointed out, she may need some of that money for legal fees so better to keep it accessible.

Just wanted to ditto this here as well. Mine turned ugly and the only peace of mind I had was knowing that I had just enough liquid to get me through court.

The only other thing I would comment is to make sure that she has her own separate finances.

[jodi]

Anyone know if divorces can be less expensive if they are uncontested, wiithout many assets to split? Just wondering if the $10k+ figures are for any divorces, or only ones that get ugly or have a lot of assets. The only assets in this situation would be the house, unless he can lay a claim to any retirement benefits she has through her work? There are no big bank accounts, stocks, or IRAs.

[sweeps]

Originally Posted by jodi

Anyone know if divorces can be less expensive if they are uncontested, wiithout many assets to split? Just wondering if the $10k+ figures are for any divorces, or only ones that get ugly or have a lot of assets. The only assets in this situation would be the house, unless he can lay a claim to any retirement benefits she has through her work? There are no big bank accounts, stocks, or IRAs.

There was an article about this in Money magazine recently. Link

Edited to add: There is a similar article in SmartMoney. Link

[Scanner]

This is a misconception. You're always paying the same interest rate on your mortgage, whether you're in the 1st year or 20th year of your amortization schedule. The interest is calculated based on the remaining balance. So in the beginning when you have a larger balance, the interest payment comprises the bulk of your monthly payment, and as your balance gets smaller over the years, the bigger part of your monthly payment is going toward the principal. However, you're still paying 11% interest.

I am not certain it is - for some loans, like my business revolving line of credit and my auto loan, it seems an equal amount of interest vs. principal is figured into the calculation each month.

For my mortgage, we've paid down 3 of a 25 year mortgage and it still seems like the balance is fairly high, for having paid about $36,000 on it so far.

One should probably check how your mortgage is amortized - maybe it's different for ARMs vs. Fixed too, I don't know.

[Scanner]

Never mind, it seems we agree. . .yes, it makes sense to pay down on the first half of the mortgage.

[kv968]

Originally Posted by jodi

Anyone know if divorces can be less expensive if they are uncontested, wiithout many assets to split? Just wondering if the $10k+ figures are for any divorces, or only ones that get ugly or have a lot of assets. The only assets in this situation would be the house, unless he can lay a claim to any retirement benefits she has through her work? There are no big bank accounts, stocks, or IRAs.

All I had to pay for in my divorce was for the proper paperwork. And that's even if there was anything owed with that, I don't really remember. I gave her the house and she left my 401k alone. Many wanted to smack me in the head for giving up the house, but we both were comfortable with it and that's it. Amicably is definitely the cheaper way to go if it's possible to do it that way.

[jodi]

That's good to hear - I got a little scared after reading that article saying divorces could "only" cost $10-12k. I think this couple could definitely do it amicably. They are not exactly "speaking" as he moved out of state, but they do communicate via e-mail over any matters that arise. I don't see too much dispute over who gets what.
Still, I will advise to keep the money liquid for now. I referred the person in question to this site, so maybe she will pop on here and stick around I told her that was a ton to learn here and lots of nice, knowledgable people to talk with.

Thanks for the links and info.

[Homebody]

I may be wrong, but I understood that an inheritance is NOT considered part of community property. She needs to check on that and if it comes through before a divorce or legal separation, she needs to put that separate to document.

My parents were legally separated and split their assets at one point and never did divorce. It was just like one though as far as money was concerned.

[Saving in So Cal]

If the divorce will be amiable, then why not just get it done. In California, a staggering percentage of divorces are handled without divorce attorneys (because of the cost). Consequently, the court system employs family law facilitators and mediators to help unrepresented parties get through the system and come to agreed upon dissolution terms. I doubt California's situation is unique. Your relative should go to your court system's website and see what self-help tools are available to her.

As far as what to do with the money, holding it a new, separate bank account (so she can more easily establish that it was given to her post-separation) seems like a prudent thing to do until the divorce is final.