I’ve never had much luck saving before this past year or so, but I finally figured out a way to do it fairly painlessly by having the bank take a certain amount out of my checking account and moving it to a CD saving account every two weeks. So now I have a little nest egg that might get me through a rough spot if one comes by, but I’m wondering if I should split some of it off and use it to either invest in something that pays more than 3% interest, or to pay down my mortgage or car(both 7% interest, though I’m already making double payments on those). Those are my only two debts, thankfully, but it’s so frustrating not to be able to pay them off faster.
When you say CD account, is this an actual certificate of deposit that has a specific maturity date? If so, you may not be able to withdraw the money early without significant penalty.
There are many savings accounts that offer 5% interest, fully FDIC-insured, with no withdrawal penalties. ING Direct offers them, as does Citibank (but you have to be a Citi customer already.) If you put your cash into one of those, you’re only “losing” 2% on the debt. You still have the debt payments, but you’ve got an emergency cash stash as well.
If you pay down your debt, you will save interest money in the long-term, but it means sacrificing some (or all) or your emergency cash. Remember that your loan payments will remain the same month-to-month, you just make the term shorter. (Unless you refinance.) So even if you pay off half your car loan principal right now, if you have an emergency, you’ve still got to come up with the regular payment in a month.
So my advice boils down to:
Get a better deal than 3% on your savings
Build up your emergency fund so you can support yourself for at least three months without income
Then pay down your debts as quickly as possible, highest rates first.
The way I’ve heard it is, if you have no credit-card debt, you should keep paying things as you are. Outside that, the first thing you do is save a thousand dollars. This will give you “emergency” money.
You won’t be in the situation I was, where I had no debt but NO savings and no credit, and I needed something unexpected. And the only thing I could do was go to a payday lender.
The next thing you do is, save up six months’ expenses. That’ll give you some backup in case of job loss, etc.
Then you can look at investments.
How long will it take you to pay off the car and the mortgage?
Why not do all three? It sounds like you have your debt well under control (double payments is very, very good). Save some like others have said (3-6 months tucked away sounds about right), and use the rest for investments. One thing to remember is that if your loans are at 7%, if your investments aren’t making more than 7%, your money would be better spent plugging the 7% drain. I don’t know how mortgages work in the U.S. (not very well - hah! I make joke!), but here in Canada, if I max out my extra payments, I could have my mortgage fully paid off in five years, penalty-free.
Columnist Michelle Singletary would recommend first off, making sure you’ve got your emergency fund of 3-6 months’ living expenses before doing much else. Then she’s really big on paying down debt; I think she’d suggest targeting the car because of the house’s tax advantages (you’re in the US. I assume; if not then the tax advantages are presumably not a concern). Then start to fully-fund your retirement plans at work and via other means (Roth or regular IRA). THEN, whatever’s left over would be your fun / other investment money. Making double-payments on the loans is a Good Thing.
There are financial advisers who tell you that you should keep the mortgage (not prepay at all, just your required payments) since it’s “cheap” money, and that frees up cash flow for other things that might have greater long-term results. Also this avoids tying up your assets in a non-liquid investment - you can sell stock more easily than you can sell a house. I can see their point… OTOH, the idea of a house free-and-clear in retirement, with no mortgage, is nice. Personally, we’re throwing a few extra dollars at the mortgage each month just for the psychological benefit; hopefully in a few years that’ll be more than a few dollars. We’re less than 20 years away from retirement ourselves!
Oh yeah - you will most likely be able to do better than 3% on your cash assets. Also if your mortgage is 7% fixed, it’s conceivable you could refi and get something in the low 6’s which might, possibly, be worth the fees - might be worth doing the math. On the other hand that might not be a big enough savings to make the refinancing hassle worth it.
Having no mortgage is part of our retirement planning, Mama. If you think about it, one of your biggest expenses is always rent or mortgage - no rent or mortgage means that you can live on a whole lot less income.
“Financial Guru” Suze Orman says about the same as what Mama Zappa’s columnist says - CC and car debt, emergency savings (she says 8 months tho!), retirement.
If you happen to put your emergency savings in a high-interest, easy-to-reach account, then good on you!
I’d like to make a suggestion about this. Highest rate first makes sense. But I would suggest you start with the one that charges you the most interst first.
For example, let’s say you are carrying a balance on both your MC and your AMEX. Amex has a rate ot 10% and MC has a rate of 15%. It would make sense to pay down the MC first. BUT let’s say that that you have a higher balance on the Amex. And that Amex hit’s you each month with $150 in interest and MC hits you with $94. I suggest that you make a big payment to amex and a smaller one to MC. Once amex is charging less per month then MC, then switch and make the bigger payment to MC. Does that all make sense?
Not financially. Your total interest for the month is the same. Next month - if you’ve paid more on the 15% bill, your total interest is less than if you paid more on the 10% bill. Its the total interest you are looking at, not each account.
However, emotionally a lot of people (Dave Ramsey) recommend paying off your smallest debts first. Each one gives you that reward you need. The math doesn’t work as well, but finances is about a hell of a lot more than math.
In this case though, there is a house and a car. The first thing I’d do is put away six months or so of living expenses. The second thing I’d do is pay off the car. The third thing I’d do is put enough in short term savings to buy another car so there is never another car loan. I paid off my mortgage - but I think that’s an emotional thing - not necessarily a logical thing (we weren’t getting a tax write off for it anyway). It does help emmesely with cash flow - on the other hand pay it off too early and you’ll quickly get use to that “extra” disposable income.
Dave Ramsey says finances are 80% behavior, 20% math. Sure, paying off the highest interest rate may make sense mathematically, but if you can give yourself quick Attaboy/Attagirl by slamming down the little ones, you’ll have more money to put on the bigger ones and you’ll be motivated to keep going.
Don’t try to do it all at once. First step, $1000 cash emergency fund. Second, debts, excluding house for now, smallest to largest. Third, 3-6 months of living expenses.
Once your debts are gone, getting the living expenses built up goes very quickly.
Personally, I’ve never had 6 months of living expenses in savings. Everytime it starts piling up in savings, I start moving it to the market. That sounds like a lot of money not yielding much income.
That might make me more risk-tolerant, but I’d rather have that in the market. This kind of depends on how secure your job is though. I consider the possibility of losing my job, and having the market tank simultaneously to be pretty small.
Anyway. . .my main point is this: while I agree that double-paying your debts is a good idea, I think that it’s also a great step to be moving a bit of money each month to a location you’re not tempted to spend it. However, for me, that place is the market. Each year when I get a raise, I basically try to keep living on the same amount of money, but just move the raise (or 90% of it) to an investment account.
The concept of “not spending every cent I make” is something that never seems to dawn on some people. Or, some people think, “no, I really do need it”, but like another poster said, your behavior is more important than the numbers. People with modest incomes can live inside their means just as easily as people with big incomes.
You don’t say much about your age, income, family status, and other factors, but should realize are doing really really well - far better than so many of your fellows. Reasonable car and house payments are not unacceptable debt - congrats on not carrying CC debt. And you are already working towards paying them off early. I’m not sure you need to go overboard trying to retire them earlier than you are. Of course, keep an eye out for refinancing opportunities where you might be able to reduce the term of your home loan.
And congrats on starting saving something. Now that you have a small nut, look at slightly more profitable yet still safe and liquid investments - such as money market accounts. Or maybe put some into bonds or T-bills to diversify. And eventually you are going to want to consider the longest term - retirement, and start even a very small but regular investments in an IRA, 401K, etc.
Bottomline, tho - you are doing very well.
-Don’t change anything drastically.
-Be sure to remain sufficiently diversified.
-Don’t assume any risk you are uncomfortable with.
-Don’t “bet” anything you cannot afford to lose.
-Be very wary of assuming any additional debt.
-And convince yourself of the fact that even small contributions bear tremendous advantages when done consistently over time.
(Just this a.m. I ran the numbers on a couple of my longterm retirement assets and was pleasantly surprised at the results, even tho the recent market has been less than thrilling. And those are accounts that are essentially below my day-to-day radar, with the cash being taken out pre-tax and invested before I see it. Other than running the numbers and re-allocating a couple of times a year, I intend to remain ignorant of it for another decade or two until I retire. Really provides some nice peace of mind!)
Personally, I like to keep some money in savings because that way I avoid fees or interest should I need money unexpectedly. Once you have a bit built up, it’s easier to invest the rest. Online savings is your best bet interest-wise; I use ING Savings (if you can get a referral, you get $25 if you deposit more than I believe $200).
You can still set up an automatic withdrawal from checking (on a schedule) or at will, and transferring money is quite easy should you need it. The rate changes but right now I’m at 4.2%. They also offer CDs (4.7 - 4.9%).
Canadian here. Reasonably high-income two earner household and 40 years old, with one child.
What I did is as follows, over the last couple of years:
I have my emergency cash in GICs (Guaranteed investment certificates), on a ladder so that there is a $2,000 certificate that comes due every month (total of $24,000 in emergency cash);
I make extra payments on mortgage each year, totalling $24,000 - to get rid of mortgage in 5 years (no tax benefits to mortgage interest payments here, sadly);
I put $25,000 in RRSP (registered retirement savings plan) - the maximum and a little extra to make up for the fact that in past years I failed to put in the maximum (has tax deferral advantages). This goes into equities;
I put $2,500 into a REIF (registered educational investment fund);
Put $18,000 into house improvements.
What I need to do I think is diversify further. Next year, I’ll see about putting some into something other than equities, inside the RRSP (until that is finally maxed out). I’m also looking at insurance vehicles with an investment component to them.
Edit: I’m a big fan of using automatic withdrawals to build up savings. I use ING for this.
That’s a valid point. If you trust yourself to not abuse it, one technique is to open up a line of credit now, when you are employed, and can easily get one. Don’t use it, but treat that available money as your emergency fund. That way you can put more of your money to work at a good interest rate and the line of credit, if you ever need it, is going to be a fairly cheap way to short-term borrow.
Thanks for all the advice, guys. I will look into finding a better interest rate for my savings account, and after I have a much bigger nest egg saved, I’ll consider peeling some off for other investments. As frustrating as it is being in debt, I feel better having some emergency money. In the past, emergency money has wound up spent on emergencies. Things like new transmissions, health care. At least I didn’t wind up further in debt.
I guess I’m feeling a little worried not to have more savings started. I’m already forty; it seems like I should be further ahead, but every time I turn around, it seems I need to get a new car, or a new furnace, or a new roof, etc. Sigh.
I’m also in my 40’s, and I have a dependent to boot.
Here’s what I would do, although as always your mileage may vary:
Get your 3-6 month emergency fund. This should be in easily accessible form - 401(k) loans don’t count (that’s more debt, even if you’re paying it back to yourself, plus the hoops you have to jump through), CD’s locking in your savings for extended time periods don’t count. I know a lot of people are down on actual bank savings accounts, but when you need money in a hurry you can get it without having to fill out forms, explaining yourself or going through other crap. (This is especially relevant to me right now, having just lost my job. I sleep a lot better knowing I have the rent and food covered for 6 months, which makes job hunting less stressful)
Pay off that car.
When the car is paid off, keep making those “payments” into some sort of investment that pays a higher rate than your emergency fund savings account.
Attack any other debts one at a time, then, again, put that “payment” into your higher-return investment/savings. Or use them to pay off another debt.
Pay the mortgage off last. Timely mortgage payments are good for your credit rating, and by the time you pay off everything else accelerating your mortgage payments should be relatively easy.
But that might not be a good idea. The best way of analyzing any choices is to look at return on each dollar, after accounting for risk. (Which is why the fairly easily accessible money market nest egg is good. But say you have a 5.5% mortgage, which looks like a 4% mortgage due to its tax advantage. If you can invest the money you’d be using to pay it off at 6%, then it makes no sense to invest it at 4. If you feel like it, you can use this money to pay it off in a lump sum when you retire. You also might decide to move to a smaller house or a less expensive housing market, in which case you might be able to pay off all that you owe and have a nice chunk of equity left. (Depending on the growth of the housing market, etc.)
I think someone has mentioned that mortgage investments aren’t very liquid. Much better to put the money someplace where you can get it out again in case of an emergency, and not have to borrow against equity.
I appreciate the emotional appeal of having no mortgage, but I’ve read enough behavioral economics to know emotional reasons are often not very good.