What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. Pension benefit options
2. Unapplied mortgage funds
3. Moving and investing simultaneously
4. Underwater home and credit cards
5. Setting priorities
6. Toilet paper value
7. First time credit worries
8. Car cost versus salary increase
9. Helping family with finances
10. Insurance priorities
My Christmas shopping is almost finished for the year. Aside from some children’s gifts, every present that I’ve picked up so far is either homemade or is something specifically utilitarian. None of those “Thanks for this…. thing” gifts – no one likes those, neither the sender or the recipient.
The one exception to that: our extended family is doing an interesting “Yankee swap” Christmas gift exchange in which everyone is putting a DVD into the mix, then we’re opening them “Yankee swap” style, which means you can swap your newly-opened gift for a gift that someone else has already opened. This will make a normally ho-hum gift exchange decidedly more interesting – and entertaining.
Q1: Pension benefit options
I got a job with a large insurance company directly out of high school. After ten years of working my way up the ranks, I took a position with a different institution. my company notified me that since I have ten years of service, I have a pension available. I can take a monthly benefit of $202/mo or a lump sum payment of approximately $4,800. The monthly annuity would begin at age 65. If I took the lump sum, they would withhold 20% for taxes. My current tax bracket is right on the cusp of the 15/25% border, so I would likely have to pay an additional 5% in taxes.
So which option do I take? On one hand, the annuity is a nice backup to my 401k savings (10% of gross income). However, factoring in inflation over the next 35 years brings the value down considerably. Also, this is a company with a choppy history – what guarantee do I have that the pension will be available in 35 years? Is that a serious risk? The lump sum is enough to pay off all my remaining existing debt (which is scheduled to be paid by March of next year) and cushion my emergency fund. My husband and I want to start and family in the next year and purchase a house in the next five, so debt reduction and aggressive savings are our top priorities right now. The lump sum could make this happen much faster, but I don’t want to cheat my future self out of the benefit of a lifetime annuity.
The first thing you need to find out is whether this annuity is actually a product of your company or whether it’s held by someone else. If you doubt the long term viability of the company you work for and the pension isn’t insured in any way, then I would be suspicious of the long term value of that pension.
In other words, if you believe there’s any sort of significant chance that the company providing your pension won’t exist when you’re 65, I would take that lump sum now. Just put half of it in the bank for taxes – you probably won’t need that much, but you’re better off being safe than sorry.
I’d probably use the first half of the money to finish off your debt repayment just a little faster, then turn your focus to savings.
Q2: Unapplied mortgage funds
My wife and I have a 30 year mortgage, held by a bank which I will call Fells Wargo, at 5% on a $230,000 home which we are a year and a half into. From day one, we decided to enroll in bi-weekly payments knowing that by doing this we would trim some time off of the 30 years. I’ve come to realize that the first “half” payment sits as, what is called by Fells Wargo, Unapplied Funds. The definition of Unapplied Funds on their website is as follows:
“Unapplied funds: When funds received from you are not sufficient to cover your minimum payment, it’s unclear where additional funds sent should be applied, or payments on your account cannot be posted, these funds are held or unapplied until the situation is resolved.
When there are unapplied funds associated with your loan, you’ll receive a letter instructing you how to resolve the situation or to send the additional funds required to make your payment. You can also contact Wells Fargo Home Mortgage to let us know where the funds should be applied.”
The very last sentence turned on a lightbulb in my head. If I tell them where to apply my funds, then this will cut the amount I pay in interest. Am I right by saying so? If so, how would I tell them to apply my funds? Here are some numbers to play with… Bi-weekly payment = $847.72. Last full payment: Principal = $294.25, Interest = $920.71, and Escrow = $480.48. Remaining balance = $220,677.29
You’re absolutely correct. If you request that your oddly-named bank apply your extra payments towards your principal, you’ll reduce the amount of interest owed on future payments.
Note that this does not mean your monthly payment will become lower. Instead, it means that a larger part of each subsequent payment will go towards the principal of your debt because the interest portion of your monthly payment is now smaller. What will actually happen is that your house will just get paid off quicker.
Also, some states don’t allow prepayment of home mortgages, so you may find that the money may just be refunded to you or deposited in an account of your choosing.
Q3: Moving and investing simultaneously
We’re tired of Manhattan and ready for a change. For several years we have been thinking about going into the Peace Corps. We’ve both done a lot of volunteering in the past and I spent some time living in an un-industrialized / less-developed country when I was in high-school so we do have some sense of what we are getting into. We also want to spend some time traveling. My husband is more adventurous in nature, he is very focuses on not squandering his time, youth and health ( its not unlikely that, if I were less pragmatic, we might be camping on a beach in South American right now rather than living in the East Village).
Also, we’re thinking about buying an investment property in Minneapolis. My family lives in the twin cities and we visit there 2-3 times a year. The real estate market is good right now, we can’t afford to buy in New York but we could afford to buy in the mid-west. We would hire a management company to over see the property. We have been pre-approved for up to a $275,000 mortgage at 4.25% and we’ve run all the numbers carefully – depending on the property we could likely make a few hundred dollars profit per month. The rental market in the Twin Cities is strong and worse case scenario we would be able to pay the mortgage and the Manhattan rent if we need to. We would have the rental property, ideally, for about a year before we move overseas for the Peace Corp so if it seems as though we would have to pay the mortgage long term we could postpone the Peace Corps until a later date.
My question is – are doing BOTH of these things risky? I like the IDEA of buying a property that will hopefully increase in value or at least have renters to help pay off the mortgage while we spend a few years overseas. This will also make me a little more comfortable with the idea of not actively contributing to a 401K or IRA for a few years because I would be investing towards my future in another way.
I don’t have a full picture of your financial state, but I will say that you shouldn’t even consider doing this if you don’t have enough cash in the bank to cover all of the mortgage payments while you’re out of the country doing the Peace Corps gig.
If you don’t do this, you set yourself up for a very sticky situation in which you likely won’t have the resources to cover the mortgage while overseas and you’re relying on a reliable renter, something I would never bet everything on.
If I were you, I’d either choose one or the other or wait until I had a pretty fat bankroll.
Q4: Underwater home and credit cards
I recently got married and my husband and I are in a unique situation. We both own houses that we rent out and we are currently living in a house my mom owns and paying her rent of $1250 per month. My husband owns a home with his sister and until recently she was living there with a roommate and he paid a third of the mortgage. Now she has moved in with her boyfriend and their house is rented for most of the mortgage. We pay $500 a month towards that mortgage and they have no intent to make any changes to that situation.
I came into this marriage with about $20,000 worth of credit card debt and we’ve managed to pay down about $5000 of that in the past 6 months. Our original plan was to have it all paid off within two years (which is on track) and then start putting money away for a larger house than the one I own. The trouble, is my house. I rented it out when I had to move south because it was worth just about exactly what I could sell it for, and it seemed to make more sense. It’s an interest only loan at 7.4% and I pay just under $1500 a month for the mortgage. The rental income is $1,000 so it’s only $500 out of pocket for me currently. When my tenant’s lease is up in April, we plan to move back into that house for 3-5 years before buying a larger home to accommodate the kids we’ll start trying for in the spring. The problem is the house is scheduled to reset in July. We’d like to refinance – and with my husband and my incomes, ordinarily it wouldn’t be a problem – especially since by the time we’re living there again, we’ll have paid off at least another $5000 of the credit card debt. But sales in that area have declined and I’m about $30,000 underwater. I have no idea what to do now. Paying more for the mortgage when it resets won’t break us (I hope) but I’d like to get better terms. We’re not behind, we’re not in dire straights, but is it even possible to refinance when prices are so low? I don’t see how we could qualify for assistance; we make around $7,000 a month. Oh, and we can’t refinance until we’re living there, because if I’m renting it out, it’s considered an investment property and when we asked our credit union, it was going to cost $10,000 just in fees & closing costs.
If I were you, I’d move into the house at the first possible instance in April and then refinance as quickly as you can before the rate resets.
I’m going to assume that you’ve been keeping up with your bills recently and thus have improved your credit rating. If this is the case, then you should be able to easily qualify for refinancing once you’ve moved into the home.
Of course, the big question is whether you can find a financial institution that would be willing to refinance an underwater home. The first business you should approach is the mortgage holder, who will likely be willing to work with you to refinance.
Q5: Setting priorities
I’m at a point where I’m unsure of where to go with my extra money every month. Here is a quick backstory on me: 29 years old, single, no children, stable job making over $100K/year. I currently have about 5 months of expenses in an emergency fund. My only debt is the $165K balance on my mortgage at 4%, and $20K in student loans at 2.13%. I am currently putting 13% of my pay to 401K (some of that is Roth so it is post-tax), and my company is putting in an additional 3%.
My immediate near term goals are to add another month to my emergency fund to get 6 months worth of expenses, and increasing my 401K to the annual max. After doing these two things, each month going forward after paying all bills and other expenses I will have about $1,000 left over. Here are what I see as my options, in no particular order (feel free to add more options):
1) Continue to add to savings for a bigger emergency fund
2) Start paying extra on my mortgage (keep in mind the low interest rate)
3) Start paying extra on my student loan (keep in mind the VERY low interest rate)
4) Start investing more money into a brokerage account for stocks/bonds/mutual funds (I already have about $15K invested in a personal account)
5) Contribute to an IRA (can I do this if I’m fully funding my 401K?)
6) Purchase my company’s stock (we are an S&P500 company that everyone loves) at a 10% discount through our ESPP and sell whenever the window opens that allows us to sell (typically a one week period once a quarter). Assuming the stock didn’t go down 10%, I will have made money (although taxable). If the price goes nowhere, that’s a 10% return (greater when annualized). If the stock goes up, that’s an even greater return. I also get a decent quarterly dividend with a current yield of about 4%.
7) Other potential options I didn’t list that you recommend
These are all worthwhile options, but before you commit to any of them, you need to figure out why you’re saving. What are you saving for?
If you can’t think of a specific reason that you’re saving, I would focus on eliminating all of your debts, starting with the higher interest ones. I know that they’re relatively low interest, but doing it anyway has two benefits.
First, a debt prepayment is basically a guaranteed investment that returns the interest rate of the debt. So, if you’re prepaying a 5% loan, that’s basically a 5% return that you don’t have to pay taxes on, which is pretty good.
Second, eliminating debts early gives you personal and career flexibility that you’ll never have with a debt hanging around your neck requiring you to make a payment each month.
Q6: Toilet paper value
Up until about 3 years ago or so, I used to be able to tell if a sale on toilet paper was really a good deal or not. Now that companies are doing the double & triple-roll thing, I can’t tell if a sale on toilet paper is truly a good deal or not. Do you have any rule of thumb on this?
I use sheet count. Of course, this will require you to have a calculator with you unless you’re really good at mental math.
Take the cost of the package. Divide it by the number of rolls in the package. Divide that by the number of sheets per roll, and you’ve got the cost per sheet. The lowest cost per sheet is the best bargain, but you can obviously restrict that by brand or type as you wish.
Obviously, companies do this to make comparison shopping a bit tougher. I don’t like it, but we all need toilet paper (or a bidet, I suppose).
He has his first job straight out of high school. He makes about $26,000 a year after taxes.
He splits an apartment rent with a brother who makes the same amount. The brother is going to college to become an engineer.
I can show him how to build credit, however; I want him to know much more than just how to buy stuff.
To my knowledge, he spends all he earns, and has no emergency fund.
I believe that getting credit for the first time and the responsibility that goes with it would be a good post.
I would like to show him the good, the bad and the ugly about credit.
Responsibility with one’s money isn’t something you can teach very well without a willing student. If he has no interest in getting his finances straight, then you can talk all you want but it will just go in one ear and out the other.
If you want to interest him in good personal finance, I would start with goals. Wait until he’s able to articulate things about his future that he actually wants, then start looking about how to get there.
I find that connecting goals to the mundane nature of personal finance is the best way to get people interested in and excited about it.
Q8: Car cost versus salary increase
I’m currently on the hunt for a new job. I live in Australia where the job market and economy isn’t anywhere near as unstable as the USA. My boyfriend and I are a one-car family and I bike or public transit to work. Some of the new jobs I would like to apply for include a 20-25K jump in salary range. So I’d be making significantly more. However, some of these jobs would also necessitate the purchase of a second car. Unfortunately we can’t switch positions as my boyfriend can’t take public transit to his job. This second car would most likely be a 4wd pickup truck (used) as it would benefit his career (furniture builder which requires moving significantly large pieces of furniture obviously) and our lifestyle (we enjoy a lot of camping and 4wd trips with friends and family). Unfortunately I don’t have the cash to buy a car outright. At what point does a car payment, insurance, petrol, etc. negate a 20K+ salary increase? Am I better off only applying for jobs I can public transit to?
A $20,000 salary increase is well worth buying a used car for, without a doubt. (Yes, I checked the exchange rate – US dollars and Australian dollars are fairly close.)
From what I can tell, you can get a reliable used car for $8,000 in Australia. I don’t have good numbers on petrol and insurance prices there, but unless they’re enormous and far beyond the scale of prices in the United States, it’s worth it.
The deal gets even better when your car is paid off and you’re just pocketing that money.
My brother-in-law and his wife have been having financial trouble for a number of years, including difficulty with holding down full time jobs due to the economy, and as a consequence of both low income and poor spending habits they frequently do not manage to stick to the “spend less than you earn” rule, despite low living costs in the small town in Iowa where they live. Consequently they frequently ask my in-laws for money to help pay their bills, sometimes up to $1000 in a month. While they want to help out my in-laws are retired and on quite a low income themselves, their retirement savings were hit by the market crash, and we would all prefer that they were able to be saving up their money for the future, or even better spending it on enjoying their retirement rather than constantly having to rescue their kids.
Can you offer any advice on help or advice we could be offering to my brother-in-law to help to get them on a better financial track? They have a 3 year old and are about to have another child next month so it is only going to get worse with the increase in costs and decrease in income when the baby arrives and my sister-in-law stops working, we are really worried about both families financial situation. While we are reasonably financially stable ourselves we aren’t really in a position to be handing them money regularly, we could help out in an emergency but that isn’t really going to solve the problem in the long term anyway.
In addition, do you have any advice on how to broach a subject like financial advice to family members without offending anyone?
Much as I responded to Joan above, it’s extremely difficult to get people interested in personal finance if they don’t care about it.
Also, as I stated above, the best method for getting people interested is to focus on goals. Is this a lifestyle they want to sustain over the long haul? Where do they want to be in the future?
I’ll freely admit that I find it uncomfortable to talk to my siblings about personal finance. It’s just not a subject that goes well between us, so I just let it lie.
If I were you, the closest I’d get to the subject is goals. Talk about where you want to be in five years with them and then clearly state how you’re going to get to where you want to go. Don’t tell them how to do anything.
Q10: Insurance priorities
How would you rank the following with 1 being the most important and 5 being the least important: accident, disability income, health, life, and major illness? Also, what percentage of one’s pre-tax income should be allocated to each of these items? You could put in 0% if you think I shouldn’t get this type of insurance.
It depends heavily on the situation in your life. Do you have children? Are they young or are they near adulthood? Are you married? Is your spouse in a financially independent position, meaning would your spouse be able to survive without you?
Is there a history of disabling illness in your family? Do you work in a career where you’re at risk for disability?
Those questions will help lead you to what the most important insurance types are for you. There is no ready-made solution that works for everyone.
Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag. However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.
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