Positive Cash Flow - Invest or Reduce Debt?

[Emelianenko]

I'd imagine the answer is simple. If the ROI % is greater than the % interest you're paying on your debt, than invest. If not, then reduce debt. If that's it, that's it.

My situation. I have a 30 year fixed mortgage on my home. I still owe about $120k. I'm currently paying 5.125% interest on the loan. If I take all my excess cash flow beyond my current expenses for the next 2 or so years, I will be able to eliminate my mortgage. For the past year, I've done nothing but accumulate money with the idea that I will have some sort of investment opportunity that will reap a greater reward than paying down my low interest rate mortgage. I have yet to find an investment with that type of return.

With a positive cash flow of close to 50k per year, what would be the smartest thing to do with the money? Pay off the debt or find an investment with a greater return than the interest on the mortgage. If a safe one exists, I'd love to hear about it.

Thoughts? I'd appreciate the feedback.

[YLTL_Dan]

I'd work to pay off the house asap. Once you do that, you can continue to save money to invest. You'll get a guaranteed return on the mortgage pay-off, and additionally becoming debt free can give you an awesome peace of mind.

There's nothing I know of that'll give you a guaranteed 6%+ return.

[JoeP]

You didn't mention an emergency fund. I'd establish one of those first, and then attack the mortgage as planned. That way, if something goes wrong during your journey, you won't lose traction or get disappointed in a schedule slip. Once your mortgage is paid off, I'd look into a successful financial adviser suggested by a friend.

[LivingAlmostLarge]

Retirement? Are you saving for that?

[jpg7n16]

Refi mortgage to lower rate, and invest excess funds.

I pretty much hold to your first line, with a small cushion added for the risk premium of investing.

[Emelianenko]

Retirement is on my mind, but again, short term and long term, I don't see the benefit of doing anything but paying off the debt if there are no investments that will create a higher return.

[LivingAlmostLarge]

A 401k saves you right now 15% on federal taxes, possibly 25%. You cannot go back in time and fund a Roth IRA and 401k while paying off the house.

I wouldn't put retirement on hold to pay off a home. I think everyone reading this thread would agree. Most probably think you are saving for retirement.

To me from your last post it sounds like you aren't doing anything but trying to pay off the home.

[jpg7n16]

Retirement is on my mind, but again, short term and long term, I don't see the benefit of doing anything but paying off the debt if there are no investments that will create a higher return.

This post makes it seem as though you don't think there are investments that will return over 5% long term. Why is that? You could also easily refi down into the 3-4% range. Do you not think there are investments out there that will earn more than 3-4% long term?


How many years do you have until retirement?

What is your understanding of the long term rate of return on stocks? Bonds?

[snafu]

With 30 yrs on your mortgage, I'm guessing that you have a long way to go until retirement. I too think you should re-fi to a lower [3.5] rate, as it is significant due to the way amortization tables are structured. Just run the figures to work out possible savings. If your employer offers any matching retirement funds that is totally free $$$ plus the tax deduction. Long term retirement funds can ride out the vagaries of the market and there is RISK in everything. Just now money in savings accounts or Money Market are not keeping up with inflation so you are losing buying power.

If the terms and conditions of your mortgage allows for extra payments or 'balloon' payments right off the principal you could reduce mortgage and fund your retirement.

[Emelianenko]

To answer some questions:

1. I'm 25 years old. In an ideal world with lofty goals I'd retire in 25-30 years. I'm currently self-employed so my income can deviate and carries more risk than most people.

2. Through my indecisiveness over the past year, I've created an emergency fund that sits in my .5% interest bearing savings account. So yes, I do have an emergency cushion if needed.

Ultimately, my concern is that it would be tough to find something with the guarantee of 5% that eliminating my debt would present. I'd prefer to have investments that don't carry a ton of risk to help mitigate the fact that my current income carries plenty of risk. What happens if I make some investments that crash and in a year my income is gone? Now instead of the investment that could've generated 5% (reducing debt) I'm stuck with liquidating my investment at a loss in order to keep up with a mortgage. I'm just a fan of the 5% guarantee. I just don't know where to find that these days.

With this being the case, for those suggesting the refi route, where would you look to invest the money?

[jpg7n16]

Ultimately, my concern is that it would be tough to find something with the guarantee of 5% that eliminating my debt would present. I'd prefer to have investments that don't carry a ton of risk to help mitigate the fact that my current income carries plenty of risk. What happens if I make some investments that crash and in a year my income is gone? Now instead of the investment that could've generated 5% (reducing debt) I'm stuck with liquidating my investment at a loss in order to keep up with a mortgage. I'm just a fan of the 5% guarantee. I just don't know where to find that these days.

If you invest and the market crashes, you'll still have a portion of your money available to live off of until you find work.

What happens if you pay all your excess cash towards your mortgage and you lose your job? You'll have no excess to live of at all.
What happens if you pay down your mortgage, and the real estate market falls and eats up all the equity you built up? And then you lose your job. Then what do you do?

With this being the case, for those suggesting the refi route, where would you look to invest the money?

In a well allocated long term portfolio. Such a portfolio is expected to make 7-11% long term. Might lose money in any given year, but you'd expect over such a long timeframe to make a lot of money.

[Emelianenko]

If you invest and the market crashes, you'll still have a portion of your money available to live off of until you find work.

What happens if you pay all your excess cash towards your mortgage and you lose your job? You'll have no excess to live of at all.
What happens if you pay down your mortgage, and the real estate market falls and eats up all the equity you built up? And then you lose your job. Then what do you do?

As I said earlier, the indecisiveness over the past year has given me quite a cushion should something happen with work so to me, the bigger issue exists if the money stops coming in and the debt still exists. At that point I have to hope that my long term investments have been on the positive side of 0% in the short term so I could liquidate to pay down the mortgage.

As for the build up of equity in regards to the home's value and potential loss in the home's value, this factor exists regardless of the route I choose. I can't control the housing market. I however can control if I'm guaranteeing 5% vs a variable 7-11%.

The more posts I make on this thread the more I feel like I'm just trying to get validation on a decision I've already made. I think one of the biggest factors that I may not be stressing enough is my comfort level with a not guaranteed investment. At this point, because I am self employed and there is a higher risk of losing my current cash flow, I'd like to mitigate this with a risk less investment, which at this point seems to be paying down the 5% mortgage.

[jpg7n16]

As for the build up of equity in regards to the home's value and potential loss in the home's value, this factor exists regardless of the route I choose. I can't control the housing market. I however can control if I'm guaranteeing 5% vs a variable 7-11%.

My mindset is more of a not looking at the guaranteed 3.5% (refi, lower with tax deduction) vs 7-11 (which is a big factor for me) - but really more of a "what position will you be in if X happens"

Yes, your house goes down either way. But if you lose your job what position would you rather be in: a) Upside down $25k on your home with $25k of extra funds on hand you can use to buy food for your family until things turn around? Or b) break even on your home with no excess to use for living expenses? You can use investments to supplement cashflow if you lose your job. You cannot use equity in your home to supplement cashflow if you lose your job.

Add to that the fact that investments are expected to earn more (MUCH more) long term than a 3-4% tax deductible loan -- and I'll pick option A every day.

Trying to give you some additional things to consider.

IMO there are some great benefits to investing over paying a small loan down:

• significantly higher expected return: 3% vs 7-11% may not seem like a lot, but over 30 years, it can be anywhere from 3-11x more for each dollar today
• access to funds for living expenses without having to sell your home
• a great start on having funds to live off in retirement (you can't live off your house in retirement)

The more posts I make on this thread the more I feel like I'm just trying to get validation on a decision I've already made.

Not that you'll take me up on it, but I truly feel it's in your best interest to refi and invest.

If I can't convince you to do it for 100%, maybe you'd be open to some 50/50 split? Use half your excess to pay down debt, and the other half to invest. That's better than nothing.

[mrpaseo]

I'd imagine the answer is simple. If the ROI % is greater than the % interest you're paying on your debt, than invest. If not, then reduce debt. If that's it, that's it.

My situation. I have a 30 year fixed mortgage on my home. I still owe about $120k. I'm currently paying 5.125% interest on the loan. If I take all my excess cash flow beyond my current expenses for the next 2 or so years, I will be able to eliminate my mortgage. For the past year, I've done nothing but accumulate money with the idea that I will have some sort of investment opportunity that will reap a greater reward than paying down my low interest rate mortgage. I have yet to find an investment with that type of return.

With a positive cash flow of close to 50k per year, what would be the smartest thing to do with the money? Pay off the debt or find an investment with a greater return than the interest on the mortgage. If a safe one exists, I'd love to hear about it.

Thoughts? I'd appreciate the feedback.

I understand your thought process, I actually did much the same thing but I was able to pay my house off in 1 year.

Here is what I suggest:

1. Six month emergency fund in a Savings or Money market. I say six months because you are self employed and you have cash on hand.
-----a. This will secure your income for at least 6-9 months. It is known that when income stops, we become tighter in how we spend/waste so a 6 month e-fund could last an additional 3 months.
-----b. This can also partially be used for the "opportunity money" that you speak of.

2. Max your ROTH IRA.
-----a. The return on a ROTH in the long run will outpace any alternative that you can think of. Besides, it's only $5,000 (Unless you are married, then it is $10,000).

3. The remaining balance of your savings goes towards the mortgage.

-----

As for self employed, I would imagine you have a budget set now since you have positive cash flow. I recommend the following.

1. Open a bank account and have your money directly deposited into it.

2. Set up a monthly transfer to cover your monthly bills/expenses.

This will offer you a set of money coming in that you can learn to live on. It's hard to run a budget when you have different amounts coming in monthly and you tend to "Treat" yourself with the extra money when you have a good month.

For example:

Income:
week 1: $1,000
week 2: $800
Week 3: $640
Week 4: $880

All this goes into your new bank account.

Then set up an allotment for $800 a week to transfer to your budgeted account. Ensure your budget is at $800 a week or below and you will be good.

The extra money will build up ($3,320 income - $3,200 = $120 extra in the account) in the bank and every quarter or so you can give yourself a bonus or invest the extra money.

NOTE: I'm not saying you are having issues budgeting, I'm just giving you an option to move to a fixed income.

3. Refinance your home:
-----a. 3% isn't hard to get these days, this will offer more to save/invest.


Another option that many will not recommend is that once you pay down your home, obtain a Home Equity Line of Credit (HELOC). They usually come in $25,000 increments and you can get $50,000 pretty easy. Then, you could use the HELOC as your emergency fund (This is the part that many do not recommend). The way I use it is I lowered my e-fund to three months because I hate having over $10,000 sitting in a bank earning nothing but a few thousand is alright. When there is an emergency, I use the cash first with the HELOC as my back up (Though I have never used it in an emergency).

Keep in mind, the HELOC is a tool, just like a CC. they are not an additional source of income, they are a tool used to spend the money that you already have.

Best of luck,
Ray

[MonkeyMama]

To answer some questions:

1. I'm 25 years old. In an ideal world with lofty goals I'd retire in 25-30 years. I'm currently self-employed so my income can deviate and carries more risk than most people.

2. Through my indecisiveness over the past year, I've created an emergency fund that sits in my .5% interest bearing savings account. So yes, I do have an emergency cushion if needed.

Ultimately, my concern is that it would be tough to find something with the guarantee of 5% that eliminating my debt would present. I'd prefer to have investments that don't carry a ton of risk to help mitigate the fact that my current income carries plenty of risk.

In your shoes, I'd pay the mortgage off.

Leveraging and investing is fine, but you are talking about being risk-adverse and having volatile income. Plus, you are only 25. Just to chime in and say that I don't think paying off the mortgage is a "bad idea" by any means. The swaying factor on these things is how long it takes. If you want to not put a cent into investing or retirement for another decade while you pay off the mortgage, well, that would be a WHOLE other thing. But we are talking about a 25-year-old who will have mortgage paid off in about 2 years, and who has a very realistic retirement goal (30 years).

I also wouldn't bother with the refi, for a mortgage that would be paid off so quickly. (Savings won't be worth hassle and cost).

One other thought:

-You could possibly be a lot more tax efficient - there are incentives to put money into retirement (SEP IRA?). Which could make the ROI on investing much higher if you consider tax incentives. From a math standpoint, this might sway you a bit. & honestly, you don't have to put this money into the stock market if it makes you feel uncomfortable. You can keep it in cash, bonds, or whatever you decide. A 25% current tax break might make this option enticing.