Ask Bankrate: Questions about house payments and retirement, student loan debt and more

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Ask Bankrate is a recurring feature where Bankrate’s experts answer your financial questions. Visit this page for more information on how to submit your question. Click on a question here to jump straight to it.

Questions:

Q1: Pay down my mortgage or contribute more to retirement?

I’m 34, and the only debt I have is my house. I owe $274,000 that I just refinanced down to 20 years with the first payment due Aug 1. I make around $100,000 a year, give or take $5,000 depending on overtime. I have a wife and two kids, but my wife does not work. I will retire earlier than many because I can draw my pension at age 60 with insurance until I hit Medicare. I currently contribute 4 percent to my 401(k), non-matching, 2 percent to an online brokerage, and 6 percent a year to my Roth IRA, which I just opened. With my wife not working, should I contribute more to retirement or focus on paying off the mortgage? Our pension will be about $50,000 a year. I do have a fully funded, six-month, emergency fund.

— Chad M.

Answered by James Royal, Bankrate senior investing and wealth management reporter: “Congratulations on thinking carefully and holistically about your retirement. Your diligence puts you in a good position and gives you some useful options, and having an emergency fund already means that you can now think about where the best use for your cash is.

You should consider the balance between the higher long-term return of a diversified portfolio of stocks – the S&P 500 index has returned about 10 percent annually over many years – and the lack of liquidity in a house. That’s perhaps the key trade-off here. What’s the cost of paying off your new mortgage? Living mortgage-free is the dream, of course, but once the mortgage is paid off, your money is locked in the house and inaccessible unless you take out a mortgage or sell the house. So you have high security this way but lower returns. After the mortgage is paid off, if you lose your job, you might be able to scrape by since you have no house payment (taxes excluded).

On the other hand, think about the options if you keep paying the minimum mortgage payment. If you have a mortgage at 3.5 percent, you’ve gotten a historically low rate and cheap long-term money. You can use that to work for you by investing in potentially higher-return assets such as a diversified portfolio of stocks. The thinking goes: Why pay off a cheap mortgage when I get a better return elsewhere? This way you diversify your assets, adding stocks to your key asset of housing and overall reducing your risk. You could add more to your 401(k) plan or have even greater liquidity by contributing to a taxable account, or split the difference. The taxable account gives you some options in case you need emergency funds, though if you invest in stocks you need to think long term, at least three years out. Plus, if mortgage rates fall further – not a great chance, but still possible – you could refinance into an even cheaper mortgage. In this strategy, you retain more options and potentially higher upside but arguably at the cost of less security.

A key element here is your temperament. Do you need the security of having your house paid off? Maybe not, if you have your emergency fund. But if you invest in stocks, you’re likely to be underwater on your investment at some point, even if the long-term returns are greater. So you’ll need to think about your financial situation and your needs. And if you opt for a higher-return, higher-risk strategy, it may even make sense to add to your emergency fund, too, so that you have greater protection if you need it. You have options – and that’s a great place to be!”

Q2: How do I invest when I have student loan debt?

I have $20K in savings but owe $50K student loans. How do I pay myself with debt and no investments? I do not know how to invest.

— Fran P.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “First off, congratulations on the $20,000 in savings. That is a valuable emergency cushion to have, so plan on keeping that as is.

For your federal student loans, I would make only the minimum payments required to pay them off over the term and allow yourself the most breathing room in your budget. This is how you will have money to invest, boost emergency savings and pay off higher-rate private student loans or other debt.

To get started investing, it’s easiest if done automatically. If you have an employer-sponsored retirement plan, such as a 401(k), your contributions can be made directly from your paycheck. If not, open an IRA with a brokerage or mutual fund company, and have money automatically transferred from your checking account on a monthly basis. With a traditional IRA, you may be eligible for a tax break on the amount you contribute but will need to pay taxes when you make withdrawals in retirement. With a Roth IRA (or on Roth 401(k) contributions), the money you contribute now is after-tax, but there is no tax obligation when you make withdrawals in retirement — it’s all yours. In either case, your money will grow on a tax-advantaged basis.

Consider what is called a target-date retirement fund. This is an all-in-one investment that takes into consideration your age, automatically investing on an age-appropriate basis and rebalancing in the years ahead as you get closer to retirement. Studies show that 90 percent of an investor’s return comes from the asset allocation decision — how the money is divided between stocks, bonds, cash and other investments — and these target-date retirement funds take care of that decision-making for you.”

Q3: Where should I invest funds that I may need to access?

I have an 89-year-old uncle with some money to invest, what would be the best type of account or bonds to invest in, making sure we will have access to the money if it should be needed for his care, without getting penalized?

— Mary B.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “Considering the potential need for the money in the near term, an online savings account may be his best bet. The account is federally insured, he can get to it when needed, and although yields are a bit over 1 percent, this is still considerably better than what would be earned in most savings accounts, money market funds or government bonds.

Chasing a higher yield is going to mean either:

  • Investing in longer maturity bonds or CDs (which won’t work if the money is needed right away).
  • Or investing in higher-risk options (which also would not be appropriate given the potential need for the money on short notice).

Yes, the returns are low and there are limited options, but your uncle just isn’t in a position to take risk if he might need this money in the near future.”

Q4: Does a refi make sense when the rate reduction is small?

Would it be beneficial to refinance a home loan when the interest rate reduction is minimal, say 0.25 percent, 0.5 percent, etc.?

— Kimberly G.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “In most cases, if you’re shaving less than half a percentage point off the rate, probably not.

The reason is that there are costs to refinancing and it takes time to recoup those costs through the monthly savings. With a minimal reduction in interest rate, it takes a longer time for the monthly savings to accumulate to the sum you forked over for closing costs — and in the meantime you’re out the cash.

What if you go with a no closing cost refi? If those costs are rolled into the loan balance, the higher loan balance offsets some of the benefit of the lower rate. Also, you don’t want that higher loan balance to push you above the 80 percent loan-to-value threshold where you’d be subjected to paying private mortgage insurance. By all means, run the numbers. But it typically takes a reduction of at least half- to three-quarters of a percentage point in your rate before the numbers start to make sense for refinancing.”

Q5: What term should I refinance my mortgage into?

I am 66 with 20 years remaining on my mortgage at 4.75 percent. Should I refinance with a new 20-year mortgage or 30? I don’t want to increase my payments with a 15-year mortgage.

— Mark G.

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “If you refinance into a 20-year loan at a lower interest rate, then your payments will go down and you will stay on the same timetable to have the loan paid off.

If your budget is tight and you’re looking for a more significant reduction in monthly payments, then the 30-year is an option. However, those much-lower payments come at the price of slower paydown of principal.

I would encourage you to run the numbers on the 15-year just in case. Because the rate is lower on a 15-year loan and because you’ve paid down your loan balance over the past 10 years, you may find that the payment on the 15-year loan is comparable to what you’re currently paying — but saves you five years of payments. This won’t matter if what you really need is a lower monthly payment, but wanted to mention just in case.”

Q6: Are more auto loan repossessions on the way?

Might there be more auto loan repossessions in the offing? What will that do to new and used auto pricing?

— Jim

Answered by Greg McBride, CFA, Bankrate chief financial analyst: “Repossessions typically rise in response to an economic downturn and rising unemployment. However, the repossessions themselves will likely be slower to materialize this time around, relative to previous recessions, because of greater payment relief options available in response to the pandemic.

We may not see the magnitude of repossessions that we’d seen following the financial crisis, for example, as households are generally less debt-burdened when measured relative to monthly income. What is more likely to affect new and used auto pricing is just the overall economic environment. Elevated unemployment, people earning less money and general belt-tightening by many consumers is likely to depress auto sales. People tend to hold on to their cars longer following a recession. This is likely to have a greater impact on auto pricing and incentives, more so than repossessions, over the next 12-24 months.”