What To Do with a Windfall

Q: I have $147,000 balance left on my four year-old home.  Home cost was $228,000.  I took out a 30-year fixed loan on $155,000 at 5.75%. Lately I have come into $120,000 tax free.  My question is, do I put this toward the home loan or place it in the market, which is where I have the rest of my total savings of $323,000. Thanks!

-Jerry, Kansas City, MO

 

A: Wow, you’ve described a really good situation! You’ve got a lot of equity in your home, a great interest rate on your mortgage, and substantial savings. Using your $120,000 windfall to pay down your mortgage represents a conservative strategy. It’s not wrong, but if you anticipate earning more in your investments than the 5.75% mortgage is costing, then investing the windfall should be strongly considered. So, unless your urge to have the home deed in your hands is very strong, I would consider using the $120,000 to bulk-up your investment portfolio—you can always pay off the mortgage later. This is especially true if the majority of your existing portfolio is held inside retirement vehicles (IRAs and employer plans). In this case, the after-tax $120,000 will give you a lot of flexibility.

On another note, you stated that all of your savings is “in the market.” I hope you have built a diversified portfolio of US and foreign stocks, bonds, and cash instruments. A salaried financial advisor may be able to give you some insight on how to best build your investment portfolio so you’re taking the least amount of risk and enjoying the greatest potential return—or at least just provide a second set of eyes to validate your strategy!

Comments

[Cristina]

QUESTION?

My father was in the airforce, and became mentally disabled when stationed in florida many years ago, he is now functional but a mentally disabled veteran, he doesn't remember the bank he sent his direct deposit to at the time that he was ill. How can he recover that information?

[June Walbert]

Thanks for your question, Gerald.

Consider stopping the extra principal payments for now until the dust settles. Also consider placing the extra payment money in the highest yielding savings or money market account possible so it’s standing by ready to apply to your mortgage principal later. In the meantime, continue making required payments to ensure your credit score doesn’t suffer!

[Real Estate For Sale In North Georgia]

Very informative post and gives a lot to think about. Who advised you to stop payments. Won't this affect your credit rating. I would contact a lawyer on this one.

[Gerald Branch]

We had planned to pay off our mortgage by the end of 2008, but our Mortgage Co. has filed Chap. 11 Bankrupcy. We have been advised to stop our extra payments.
What do you recommend?
Please answer.

[jim1027]

whats wrong with paying off the house avoiding interest, putting whatever his house payments are into an IRA every month and collect interest while building for retirement.

[Roger Curb]

The approach described above is in fact the conservative and risky method. What it is lacking is the understanding that when you invest that $120,000 hope to get an average of 12% (Stock market averaged 12% for the last 70+ years) and you maintain a mortgage with a rate of 5.75%, you would think that you would net approximately 6.25%. After you account for fees and taxes, you are looking at a net of around 2-4%. That is a terrible return and let me show you why. Based on the Rule of 72* at that rate it would take your money around 24 years to double. That takes too long, so pay off your house first and then invest at an average of 12%, your money doubles every 6 years.

To solve this problem lets pay down your balance from 155,000 to 33,000. (This is assuming you already have a fully funded 3-6 months of expenses-emergency fund) You kill your remaining mortgage in the next 2-3 years using a Debt Snowball**. So now that you are debt free you are ready to start investing your “house payment” for retirement. Now you will have a higher net return also a paid off home mortgage. You are also saving $50-60,000 in interest on your mortgage. If I was you, I would stop paying other people interest and start getting paid interest.

If this still doesn’t make sense lets do what is called a Sunk Cost Analysis. If you have $122,000 in home equity, would you borrow against your house at 5.75% interest to invest it at an average of 12%? Absolutely not! As you can see it doesn’t make sense to borrow against your house and create more risk now does it. The best part is that this way you minimize your risk because if something happens to you financially, the bank can’t foreclose on you’re paid off house. That’s impossible. So have a paid of house, and a higher net return and financial peace.

The only good advice that USAA provided you was to seek out a competent Financial Coach or Advisor who has the heart of a teacher and can help you understand how money works so you can make your own decisions. I recommend Primerica Financial Services (largest financial services marketing company in the US with 100,000 representative and the largest mutual fund sales force in America with 26,000 licensed representatives. All are debt certified and will help you achieve your financial goals. You can find a Primerica rep near you at www.primerica.com.

Financial Peace for you is at hand. God Bless you and I pray you will continue to make prudent financial decisions.

“I will do today what others won’t, so tomorrow I can be, do, and have what others don’t” Zig Zigglar

*Rule of 72 – Rule discovered by Einstein that tells you approximately how fast your money will double based on what interest rate you are earning. Lets say you have 10,000 you want to invest this is what it would look like at different rates.
So $10,000 invested at 3%, 6%, and 12% in a 24 year time period.

3% would double one time and would give you $20,000 (doubling every 24 years)
6% would double two times and would give you $40,000 (doubling every 12 years)
12% would double four times and would give you $160,000 (doubling every 6 years)

**Debt snowball is listing your debts smallest to largest, paying off the smallest debt first (not the highest interest) and applying the freed up debt payments to the next smaller debt until it is all gone. This has a “snowball” affect, hence the name. It aggressively attacks the interest and is the most efficient way to pay off debt, does it the fastest, and saves you more money in the long run.

[Ray Johnson]

A few years ago we were in the same position as Jerry. We chose to pay off our home in full - under one condition - the monthly mortgage payment had to be INVESTED. We have stuck to our guns and it has been one of the best investment decisions we have made. Further, we now have the security that our house is ours and no one else's. You can't put a price on that feeling. Thank you, Ray