My mom passed away, and left me her house, which I just sold and will net $250,000. I’m 41 years old with no real retirement savings. I make $80,000 a year, and I am maxing out contributions to my employer-matching retirement account. I own my car, pay off my credit cards in full every month, and my only real debt is $220,000 in federally funded, consolidated school loans. (I only took out $100,000, and have been making income-based repayments for 13 years).
“‘I want to make sure that I have access to liquid assets for a down payment once I find my home, but would also like that money to work for me.’”
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I am currently living with my best friend in his home. He does not charge me rent or utilities as I was paying the mortgage on my mom’s house, with the plans that once that it was sold, I would be free to find my own forever home; so this is a temporary situation, but it does not have to be a short-term solution. I want to make sure that I have access to liquid assets for a down payment once I find my home, but would also like that money to work for me.
I plan on still maxing out contributions to my work Roth IRA, but I am unsure where to put the remainder until I find a home to purchase. I’m looking at properties in the $350,000 to $400,000 range. Would it be better to put all of this money into a down payment to keep my mortgage lower and make minimum monthly contributions to a retirement account, or if I should use the minimum amount possible for a down payment with a higher mortgage, but put a bigger amount into retirement savings?
Dear Starting Anew,
Friends support each other, and you have good people on your side. You get back in life what you put into it. It seems like you are the recipient of the same generosity and kindness from those in your life. I salute your friend for helping to make this period of your life — dealing with the death of your mother while navigating the road ahead — somewhat easier. You are also right to take your time. It’s rarely a good idea to make big, irreversible financial decisions when you are going through a period of grief and/or significant change.
But let’s address your $220,000 in student debt first.
“After 25 years of payments (300 payments) in income-based repayment, the remaining debt is forgiven,” Mark Kantrowitz, the author of “How to Appeal for More College Financial Aid” and “Who Graduates from College? Who Doesn’t?” The forgiveness is currently tax-free, through to the end of 2025, he said, and this is likely to be extended or made permanent. Republican proposals to eliminate the forgiveness at the end of an income-driven repayment plan are unlikely to go anywhere, he added.
Your monthly payment under IBR is probably about $750 a month, given your income, Kantrowitz said. “That’s probably less than the new interest that accrues — based on interest rates 13 years ago — so you are negatively amortized. That means the loan balance will continue to grow larger. You should continue to make payments under income-based repayment. The remaining debt should be forgiven in another 12 years, given that you have been paying in IBR for 13 years. You’re more than halfway to forgiveness.”
Take your time before buying a home, and don’t leave yourself without cash flow and/or a 12-month emergency fund. Interest rates are on the rise, and we may have a recession next year. Some experts say house prices will rise at a slower rate, while others see a drop in house prices by as much as 8%. If you want to avoid paying private mortgage insurance, put down 20% of the purchase price of a $400,000 home ($80,000). But Kantrowitz said there are many mortgage options with lower down payments, especially for first-time home buyers.
Timothy Speiss, partner at Eisner Advisory Group, said you have much in your favor, considering your $250,000 inheritance. You are smart to continue to make maximum annual contributions to your employer-matching retirement plan. Speiss also advises you to review your investment asset allocation in the plan, such that you have an appropriate asset allocation At 41, that roughly equates to a 60/40 division (60% stocks and 40% bonds). “A fixed- or blended-rate interest investment fund may be an appropriate non-retirement plan,” he adds.
Larry Pon, a financial planner based in Redwood City, Calif., says you should focus on maxing out your retirement plan. The power of compounding is your friend — you will earn money on the reinvested interest over the next three decades. “At minimum, if you are getting raises, increase your contribution by those raises,” he says. “I’d like to see you put away at least 10% into your retirement account. I tell all my clients to max out on their retirement plan contributions.”
Pon suggests spending no more than one-third of your income for living expenses. That’s approximately $2,222 a month. “This would mean making a larger down payment to get a smaller mortgage,” he said. “Your housing costs include your mortgage, property tax, insurance, utilities and maintenance. Let’s assume your expenses besides the mortgage is $500/month, then your mortgage payment should be around $1,700/month. This means a $190,000 down payment and using a 15-year mortgage to get the lower rate.”
Bill Van Sant, senior vice president at Girard, a Univest Wealth Division, agrees. “I would advise saving for a larger down payment, especially given how rates have risen from around 3% up to 7%. If you put less of a down payment, you are going to be borrowing more money at a higher percentage. By leaning more toward a larger down payment, you ultimately will pay less in interest over the long run and be closer to paying off the home.”
Start looking around now, but you have time to wait and see how the housing market plays out in 2023.
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