Nicholas writes: My wife and are I are recently married and both turning 30 years old and have saved our entire life. We recently purchased a home in Long Island, N.Y., with a 3.875% 30-year fixed rate. We have a significant amount of funds in the bank as well (almost equal to our mortgage balance). We currently both max out our 401(k) plans. We have the capability of paying our mortgage off in around 11-12 years if we take our additional income each month [and] instead of putting it in our savings account, we apply it to our mortgage. My wife is extremely conservative (she would rather accumulate money in our savings account). I believe the prudent decision is to pay our mortgage off as quickly as possible as we are paying 3.875% on our mortgage and our deposits are earning 0.25% sitting in the bank. Am I being too aggressive?
From a purely mathematical standpoint, you’re right: it would be more effective to pay off a mortgage faster than to park that money in a savings account and earn next to nothing. But of course, money decisions are not always black or white, especially when you’re married. I generally recommend maintaining a rainy day nest egg of about nine months’ worth of expenses in a savings account to cover the unexpected: job loss, medical bills, broken car. It sounds like you and your wife may already have hit that number, so at this point the key is to find a middle ground where you can put the rest of your money to better work for your goals, all while understanding your wife’s concerns of losing liquidity.
Her point of view may seem conservative now, but not if you anticipate needing that money for some near-term big-ticket expense. “It’s about finding the balance,” says Julie Murphy Casserly, a certified financial planner and author of “The Emotion Behind Money: Building Wealth from the Inside Out.” “If you ignore where one of the spouses is emotionally, it will come out in other parts of your marriage. I’ve seen it happen time and time again.”
To arrive at this middle ground, begin by outlining your priorities as a young, newly married couple. Do you plan to have children soon? Go back to school? Assist aging parents? Once you identify some near-term goals you may find that saving for them precedes paying down a low, fixed-rate, not to mention tax-deductible, mortgage. For example, if babies are in your future, how much would you need to comfortably afford child care and all the other expenses of raising a family? Do you want to set aside money for private school or college? A head start can’t hurt. Might using all the extra cash to pay off your mortgage sooner compromise having enough money on hand when that day arrives? Perhaps you decide to just add one extra monthly payment a year toward your mortgage, and keep the rest in cash. Even that alone can dramatically knock down your mortgage term and save tens of thousands in interest over the life of the loan.
Long-term plans like retirement should be another key consideration. I’m sure you’ve accumulated nice-size great 401(k)s by now. But have you actually run the calculators to estimate how much you’d need to address all your retirement expenses? A 401(k) is a fine savings vehicle but you may decide it’s not enough if you want to retire slightly early or travel often after you quit the work force. With some of your extra cash, I’d suggest contributing to a Roth or traditional IRA to supplement your retirement savings.
And by the way, it’s OK if you don’t know exactly where your lives are headed. If your goal is to simply build wealth faster, another sound possibility is to use some of your excess cash every month to build a well-rounded, tax efficient investment portfolio, says to Greg McBride, CFA, and senior financial analyst at Bankrate.com. “Diversifying into other higher returning assets will help grow their nest egg for whatever future goals they may have in mind,” he says.
Matt asks: Is it OK to withdraw Roth IRA contributions to put towards a home's down payment since they are penalty-free?
Just because you can doesn’t mean you should. Yes, you can withdraw up to $10,000 from a Roth IRA penalty-free -- on the condition you’ve owned it for at least five years and you use the money for the purchase of a home -- it’s best not to think of the account as an ATM. “You’re losing some very powerful benefits by withdrawing the funds,” says Eleanor Blayney, consumer advocate at CFP Board. “That money is compounding tax-free... You’re basically undermining the goal you had when establishing the account,” she says, which is to save for retirement.
Jeffrey Levine, a certified public accountant and consultant with IRAHelp.com agrees. “The one thing you can’t get back is time, compounding interest and return,” he says. “It’s not the best option.”
Is there any other way you can produce money for a down payment by selling assets or taking another year to save? Check out my response a couple weeks ago to a reader who is cash-strapped and wondering how to afford a home. Bottom line: If you’re tempted to withdraw from an IRA and compromise your retirement, you might not be financially ready. You never want to stretch yourself too thin to be a homeowner.
Got a question for Farnoosh? You can reach her on Twitter @Farnoosh or email her at firstname.lastname@example.org.