What do I do with the money now that a debt is paid off?

[colsxjack]

In one more month my student loan debts will be paid off.

Now we are trying to think of what we should do with that money each month.

We have done fine without that money for the past 5 years.

We could:

a) absorb it into our cashflow and lifestyle

b) put it into savings for renovations

c) divide it up into different saving (ie: short term saving and long term savings)

d) pay down our mortgage

What would you do with an extra $1000 per month?

Our situation:

We are a family with two working adults. A 3.5 yr old and newborn twin boys.

My partner is on maternity leave for another 10 months. For 4 more months she has 86% of her income. For the final 6 months we are down to 55% of her income. (we are in Canada).

When we are both working, we make a solid middle class income and live in a very high COL city.

Our 3 yr old goes to daycare and will continue to until my wife's income decreases on maternity leave.

In September she will go to all day kindergarten.

She doesn't cost very much money right now because she is small, not in really any activities and does fine with second hand clothing and such.

The babies do not really cost much because they are breast fed, were second hand clothing, cloth diapers and no childcare.

Obviously our children will cost more as they grow.

We own a 100 yr old home that needs/wants lots of renovations. But we plan to do this slowly over a few years. And we plan to eventually sell and buy a larger home.

We vacation, but only to see my partners family who live on the other side of the country. We fly there on points, but rent a car and go to attractions while there.

We plan to do more vacationing in another 5 yrs or so when the children are a bit older and able to enjoy it more.

We do not have any debt. But have only small savings also.

We do have some retirement savings and pensions.

We put money away each month for our childrens education.

We do not pay extra into retirement savings or extra on our mortgage at this point.

Any advice?

[katelove]

Does you mortgage have a redraw facility? If it does then I would put it into the mortgage with a possible plan to use it for renovations in the future. You can save thousands by making extra mortgage repayments.

If you don't have a redraw facility then I might split it and put some in the mortgage and some in a savings account for renovations and maybe some for retirement depending what your other plans are there and the timeframe for renovations etc.

The one thing I definitely would *not* do is just let it get absorbed into your lifestyle spending. That seems like a big waste of an opportunity to me.

[skycheattraffic]

I agree. Don't just absorb it into your spending. I would probably split it up: some for mortgage, some savings for renos, some boost your RRSP/RESP (if needed) and maybe absorb 10% or so into cash flow if you feel it would make things more comfortable. for the mortgage, just make extra payments, don't change your monthly/biweekly amount in case you need to touch the extra money in the future in an emergency. It may be a good idea to squirrel away a couple/few months surplus into an easy to access emergency fund just in case. In a 100 year old home things can happen unexpectedly (mine is 85ish years so I can relate) and I feel really good to have a few K available in case there's a plumbing disaster or the furnace gives out.
It sounds like you are in great shape. Congratulations on being debt free. It's a great feeling!!

[LoveOurBabies]

With an extra $1000 per month, I would pour the entire $1000 into a mortgage offset savings account. You said you didn't have a lot of savings. Do you have a plan for what would happen if you or your wife found yourselves out of work in 12 months time? If it were me, I would focus on building an emergency fund (in an offset account) so that I could have the best of both worlds - Reduced interest payable on my mortgage for the life of the savings and savings that can be accessed easily, for renovations or emergencies.

I wouldn't do re-draw. Apparently even if you have paid a lot in advance, it still never looks good to re-draw that money later down the track. That's what I was told by my bank anyway (I don't live in the US or Canada so I don't know how things run there).

[EmsMom]

I don't know what is avaiable in Canada.  But if it was me, I would split that money into investments and savings.  How much would depend on the tax breaks.  Here in the US, I would chose to maximize my investments in a Roth IRA, where growth is untaxed and available at age 59 1/2.  I would putn the maximum (for me around $600) and then put the rest in a secure savings account.  I would automate the whole thing with online accounts.  Once I had a nice cash cushion (if you put in $500, in two years you could have $12000), I would start looking into the other things.  If my mortgage interest was quite high (say, more than 6%) I would probably choose to start paying that off instead of investing the full amount. I have found that nothing gives me a nice secure feeling as much as some healthy savings and investments so for me it always comes first before any wants.  Because I am a single mother, it matters to me even more.  Other important options might be to consider life insurance and disability insurance, but the need for those things might be drastically different in Canada. 
 

[LoveOurBabies]

Originally Posted by EmsMom 

I don't know what is avaiable in Canada.  But if it was me, I would split that money into investments and savings.  How much would depend on the tax breaks.  Here in the US, I would chose to maximize my investments in a Roth IRA, where growth is untaxed and available at age 59 1/2.  I would putn the maximum (for me around $600) and then put the rest in a secure savings account.  I would automate the whole thing with online accounts.  Once I had a nice cash cushion (if you put in $500, in two years you could have $12000), I would start looking into the other things.  If my mortgage interest was quite high (say, more than 6%) I would probably choose to start paying that off instead of investing the full amount. I have found that nothing gives me a nice secure feeling as much as some healthy savings and investments so for me it always comes first before any wants.  Because I am a single mother, it matters to me even more.  Other important options might be to consider life insurance and disability insurance, but the need for those things might be drastically different in Canada. 
 

I thought 6% was low.. How much is the average rate in the US? 

[Poddi]

Canada has Tax-free Savings Account (TFSA) that's similar to Roth in US.  If you don't have one already open one up for each of you.  It can be any form of investment and you can take it out for anything (just don't go over your annual deposit limit).  I use my TFSA for emergency fund and DH uses his to play with stocks.  If it's me I'd put the extra cash in emergency fund until I have about 3 months' expenses (if you already have that, great), then throw most of that at mortgage, save a small portion for vacation fund or other things.  If you don't have an adequate EF that should be a top priority.

Oh and congrats on paying off the student loans!

[EmsMom]

Last time I checked it was running around 4.25%, but that may only be for people with very good credit.  Don't really know the other rates.  The point is more that you can invest money in reasonably secure investments and expect at least a 6% return, so unless you are shooting for absolutely 0 risk (no such thing really) it doesn't always make sense to pay off a mortgage.  I know some people disagree.  But I feel that even if you pay off a house, are you really going to continue living there forever?  Even if the neighborhood goes to pot?  Even if you develop a disability?  Even when your kids leave the house?   My ex stayed in a house because he assumes he will be there forever, but in 10 years it will be way more house than he needs because the kids will be gone.  And it would cost TONS of money to make it more livable for him as he ages.  And the house is losing value because the neighborhood is deteriorating.  The same street that was thriving 3 years ago now has 4 abandoned homes in various levels of decay.  And a huge tract of land that was a nature preserve has also been abandoned by the management of that preserve which has the potential for making the whole area a haven for trouble.  Yeah, the neighborhood could come back, but it is going to be a struggle.  And locally, property taxes are a huge issue as well as they keep on rising and the property taxes alone in this area are the equivalent to a mortgage payment elsewhere (and often more). 

These types of issues have been me rethink the wisdom of sinking everything into paying off a house.  I wouldn't choose to do it anymore over other alternatives such as a well diversified investment portfolio, ideally one that includes stocks, bonds, precious metals, cash, and maybe eventually some carefully chosen real estate.  My main point is that if you sink all of your extra income into a single asset such as one house, it is just as big a risk as any other investment.  Plus it needs a great deal more maintenance than other investments.  I think that there has been a major change in the way people see houses and communities in that families don't seem to want so much any more to "invest" (as in ethically, emotionally, and with sweat equity) in their neighborhoods as much as they did even 15 or 20 years ago.  It really does change the game -- a lot.  So that house in that neighborhood that you have so carefully invested in is less likely to serve you later on in your life as your needs change.  People now seem to be buying homes to meet current needs - good jobs and flash early on, good schools for a few years, warm climate and elevators later on. 

Just for the record: I am planning to buy a house in the next 6 months or so.  For the reasons above I worry about sinking too much of my available money into it.  But I can find a house that will be less than my current rent and if I live in 5 year, even if there is a drop in value I think I will still come out ahead.  But as long as I have other investment alternatives I probably won't sink extra money into it.  And there are better alternatives here in the US:  the tax advantages alone make investing in IRAs or a solo 401K better investment options. 
 

[skycheattraffic]

Be careful with the TFSA. Be sure to pick the right kind of TFSA for your needs. Banks typically go for what gives them (not you) the greatest return and may by default go with an option that ties the money down more than you like. If you want it very easily accessible, be sure to specify a high yield savings account TFSA. We just went over this with our financial advisor.

A 6% mortgage is low?! Six years ago when we bought the house the best we could do was 4.8%. Last September at our renewal we got a 2 year fixed rate of 2.9%. That took our 27 year amortization down to 15 years (we upped our payments by $20 biweekly too). We live in a fair sized city in Ontario but the housing market isn't super hot here.

[crunchy_mommy]

If all other debts are paid off, I would probably first build up a larger emergency fund -- 6-12 months living expenses, or enough to cover major expenses (new furnace, new car, new roof) without wiping out your savings.

With $1K a month it should only take a year or so to build a decent emergency fund -- which sounds like will be a transition point for you anyway, with DP going back to work, unless you have to fall back on that extra money sooner when her maternity leave is reduced. Anyway, once you have a good EF, then I'd probably split up the extra $1K... maybe $500 extra on the mortgage, and the rest in retirement, short-term savings, renovations, etc.

Originally Posted by EmsMom 

The point is more that you can invest money in reasonably secure investments and expect at least a 6% return, so unless you are shooting for absolutely 0 risk (no such thing really) it doesn't always make sense to pay off a mortgage.  I know some people disagree.  But I feel that even if you pay off a house, are you really going to continue living there forever?  Even if the neighborhood goes to pot?  Even if you develop a disability?  Even when your kids leave the house?   My ex stayed in a house because he assumes he will be there forever, but in 10 years it will be way more house than he needs because the kids will be gone.  And it would cost TONS of money to make it more livable for him as he ages.  And the house is losing value because the neighborhood is deteriorating. 

 

As far as paying extra on the mortgage, I don't see how it could be a bad thing, unless you fear you might eventually default on the mortgage & walk away from the house or short-sale it or accept a government bail-out. If not, then you're going to have to pay that money back eventually anyway, whether you sell or not. It's not that the house is an investment, but a debt to be paid off. If you pay off the mortgage, one of your most basic living needs is practically free (minus taxes/insurance) from that point on if you continue living there. If you pay it off & sell, then you have more money in your pocket instead of most of the money from the sale going to repay the bank. If you can't sell and can't live there, you can walk away from the home almost guilt-free because at least you don't owe anyone anything on it. If the interest rate is 5 or 6% or more, it's unlikely to find a solid investment earning that much interest, or keep that money invested long enough to make it worth as much as you'd save if you put it toward a 30-year mortgage. I suppose if your interest rate is super low, 2%, or something, then rushing to pay off the mortgage might not be a "get rich quick" move, but it would still provide more emotional security in knowing your home is paid for and you are debt-free. The "risk" associated with paying off the mortgage doesn't apply in my mind. If you put $10K in stocks, you're taking an investment risk, and you may lose or gain a ton. If you put $10K toward your mortgage, you're lowering your debt by $10K, plus interest. Whether the house is a solid investment is kind of irrelevant because you owe the money either way... you already took the investment in buying the house & taking on the mortgage, now the best you can do is mitigate that risk by paying it off quickly.

But, I am far from rich lol!! So maybe I'm off base, that's just my line of thinking.

[LoveOurBabies]

Originally Posted by EmsMom 

Last time I checked it was running around 4.25%, but that may only be for people with very good credit.  Don't really know the other rates.  The point is more that you can invest money in reasonably secure investments and expect at least a 6% return, so unless you are shooting for absolutely 0 risk (no such thing really) it doesn't always make sense to pay off a mortgage.  I know some people disagree.  But I feel that even if you pay off a house, are you really going to continue living there forever?  Even if the neighborhood goes to pot?  Even if you develop a disability?  Even when your kids leave the house?   My ex stayed in a house because he assumes he will be there forever, but in 10 years it will be way more house than he needs because the kids will be gone.  And it would cost TONS of money to make it more livable for him as he ages.  And the house is losing value because the neighborhood is deteriorating.  The same street that was thriving 3 years ago now has 4 abandoned homes in various levels of decay.  And a huge tract of land that was a nature preserve has also been abandoned by the management of that preserve which has the potential for making the whole area a haven for trouble.  Yeah, the neighborhood could come back, but it is going to be a struggle.  And locally, property taxes are a huge issue as well as they keep on rising and the property taxes alone in this area are the equivalent to a mortgage payment elsewhere (and often more). 

These types of issues have been me rethink the wisdom of sinking everything into paying off a house.  I wouldn't choose to do it anymore over other alternatives such as a well diversified investment portfolio, ideally one that includes stocks, bonds, precious metals, cash, and maybe eventually some carefully chosen real estate.  My main point is that if you sink all of your extra income into a single asset such as one house, it is just as big a risk as any other investment.  Plus it needs a great deal more maintenance than other investments.  I think that there has been a major change in the way people see houses and communities in that families don't seem to want so much any more to "invest" (as in ethically, emotionally, and with sweat equity) in their neighborhoods as much as they did even 15 or 20 years ago.  It really does change the game -- a lot.  So that house in that neighborhood that you have so carefully invested in is less likely to serve you later on in your life as your needs change.  People now seem to be buying homes to meet current needs - good jobs and flash early on, good schools for a few years, warm climate and elevators later on. 

Just for the record: I am planning to buy a house in the next 6 months or so.  For the reasons above I worry about sinking too much of my available money into it.  But I can find a house that will be less than my current rent and if I live in 5 year, even if there is a drop in value I think I will still come out ahead.  But as long as I have other investment alternatives I probably won't sink extra money into it.  And there are better alternatives here in the US:  the tax advantages alone make investing in IRAs or a solo 401K better investment options. 
 

ITA about neighbourhoods changing and people buying to suit current lifestyle. Personally, we're only planning to stay in our house for another 5 years or so.. It will be outgrown by then.

I'm assuming that your mortgage interest rate decreases according to your credit rating, in the US? If so, that's a pretty good compromise. We don't seem to have anything like that where I live. It's take the current rate or leave it. Even the fact that we dumped in excess of 30k (on top of the required payments) in the first 24 months with our previous mortgage, didn't help our application when we chose to buy a house again 4 years later. The first house was sold voluntarily by us with a tidy profit, so it wasn't a case of defaulting/bank repossesion and ruining our credit history at all. The banks couldn't give a toss. It was pretty much based on current income, savings and dependents.

Originally Posted by skycheattraffic 

Be careful with the TFSA. Be sure to pick the right kind of TFSA for your needs. Banks typically go for what gives them (not you) the greatest return and may by default go with an option that ties the money down more than you like. If you want it very easily accessible, be sure to specify a high yield savings account TFSA. We just went over this with our financial advisor.

A 6% mortgage is low?! Six years ago when we bought the house the best we could do was 4.8%. Last September at our renewal we got a 2 year fixed rate of 2.9%. That took our 27 year amortization down to 15 years (we upped our payments by $20 biweekly too). We live in a fair sized city in Ontario but the housing market isn't super hot here.

2.9%!! We would never see that rate here. I wish.. We're currently at 5.6% and that's after a discount. I still remember that when my parents were paying their house off in the 90's, rates were at 16-17%, so we've always considered the 5-6% mark "low".

--------------------------------

Edited to add: Sorry to the OP for derailing!

[A&A]

Originally Posted by LoveOurBabies 

I thought 6% was low.. How much is the average rate in the US? 

 Ours is just under 4%.

I would put $900 a month into long-term savings, and $100 toward fun spending.  (Maybe saving for a vacation, etc.)  

[EmsMom]

Originally Posted by crunchy_mommy 

If all other debts are paid off, I would probably first build up a larger emergency fund -- 6-12 months living expenses, or enough to cover major expenses (new furnace, new car, new roof) without wiping out your savings.

With $1K a month it should only take a year or so to build a decent emergency fund -- which sounds like will be a transition point for you anyway, with DP going back to work, unless you have to fall back on that extra money sooner when her maternity leave is reduced. Anyway, once you have a good EF, then I'd probably split up the extra $1K... maybe $500 extra on the mortgage, and the rest in retirement, short-term savings, renovations, etc.
 

As far as paying extra on the mortgage, I don't see how it could be a bad thing, unless you fear you might eventually default on the mortgage & walk away from the house or short-sale it or accept a government bail-out. If not, then you're going to have to pay that money back eventually anyway, whether you sell or not. It's not that the house is an investment, but a debt to be paid off. If you pay off the mortgage, one of your most basic living needs is practically free (minus taxes/insurance) from that point on if you continue living there. If you pay it off & sell, then you have more money in your pocket instead of most of the money from the sale going to repay the bank. If you can't sell and can't live there, you can walk away from the home almost guilt-free because at least you don't owe anyone anything on it. If the interest rate is 5 or 6% or more, it's unlikely to find a solid investment earning that much interest, or keep that money invested long enough to make it worth as much as you'd save if you put it toward a 30-year mortgage. I suppose if your interest rate is super low, 2%, or something, then rushing to pay off the mortgage might not be a "get rich quick" move, but it would still provide more emotional security in knowing your home is paid for and you are debt-free. The "risk" associated with paying off the mortgage doesn't apply in my mind. If you put $10K in stocks, you're taking an investment risk, and you may lose or gain a ton. If you put $10K toward your mortgage, you're lowering your debt by $10K, plus interest. Whether the house is a solid investment is kind of irrelevant because you owe the money either way... you already took the investment in buying the house & taking on the mortgage, now the best you can do is mitigate that risk by paying it off quickly.

But, I am far from rich lol!! So maybe I'm off base, that's just my line of thinking.

Even when you take the 2008 crash into consideration, the 10 year history on many investment funds is running 10, 12 percent or more.  Other types of investments could do even better.   Yes, there is more risk.  But if you have a mortgage down around 4 %, I still say that paying off the mortgage with all of the extra money may not be the best move.  I would at least look at the options of maxing out tax deferred or tax deductible investment options.  And you can actually purchase property or gold within an IRA if you structure the legal framework correctly.  This gives more options to diversify.  I am not really against paying off a mortgage early.  But personally, I would max out retirement options for the tax benefits before I started agressively paying down mortgage debt. 

I, too, am hardly rich.  And I would only walk away from a mortgage under the most dire circumstances.  But financial security is based on diversification of assets and of risks.  And I do believe that there is some risk associated with real estate, not least from the large amount of maintenance it requires.  The best answer for the OP may well be to diversify her choices with that extra money:  say $400 to emergency fund; $400 to retirement fund, $200 to extra on the mortgage.  And make it an automatic deduction from your account so it cannot just get absorbed into your budget. 

[crunchy_mommy]

I guess what I was trying to get at is...

If you have $10K, and you pay toward your mortgage with it, you are guaranteed to be ahead by $10K plus the interest on that (let's just say 5%).

If you put that $10K toward investments, it's possible that you could be ahead by $10K plus a lot of interest (10%?), but you'd still owe that $10K + 5% interest on the mortgage.
On the other end, you could end up losing some of that $10K, plus you'd still owe $10K + 5% interest on the mortgage.

So paying ahead on the mortgage is guaranteed to save you money. Putting it into investments may save you even more money (in this case, you'd earn an extra 5% interest), but also could set you back even further.

Maybe I just like safety lol. Investments sound more risky. I lost a ton of my (already meager) retirement savings a few years ago. And I still owe a lot on my mortgage.

[pek64]

If you know you want to renovate, I'd save for the renovation. At $1000 per month, you should get there quickly. And you can refinance to get a better mortgage interest rate. The ROTH IRA is good for college tuition savings or some other distant goal. CD's work for shorter term goals. They get better interest than a simple savings account. At a thousand per month, you should be able to get a higher interest money market account, if you feel better having easy access to the money. But I agree with the view of "do *not* simply spend it away every month". You're doing great, paying off the debt. Keep going and use the momentum to propel you to greater goals!

[TiredX2]

We do not have any debt. But have only small savings also.

We do have some retirement savings and pensions.

We put money away each month for our childrens education.

We do not pay extra into retirement savings or extra on our mortgage at this point.

Any advice?

It sounds like you are in a very good position going forward!  Congrats :)

I'm not very educated on retirement/investment options in Canada, so my advice might not be 100% applicable.

First, it sounds like you are comfortable with your current standard of living.  If you had been feeling deprived while paying off your student loans, I would encourage you to use some of the money to improve your lifestyle to a point at which you felt comfortable.  If you are already there, then a combination of savings and investments makes sense.

It's generally recommended to have 3-6+ months of expenses in savings.  Especially with decreased income on the horizon, that could be especially important for your family.  After that, it's considered a good idea to be putting 15% (here, on top of Social Security) away for retirement.  In the US, you are told to put money away for retirement *before* money for education because while there are loans for college, there aren't loans for retirement.   The general rule for paying off your mortgage early is if you can get investment income *safely* that is higher than the amount you are paying in interest.  At 6% I would consider that a wash.  In the 2-3% range you could get in the U.S. for several years, it leans towards not paying and once you're much above 8%, most people would lean towards pre-paying.  That said, even though we were under 5% interest, we chose to prepay simply because I have a real aversion to debt.  It wasn't the financially savvy move, but it was a relief to us.

[Basylica]

DO NOT absorb into spending!

Its like losing weight, it's always easy to put on but murder to take off. Same with spending....once you get used to extra cash it'll be gone in a flash.

What I do is everytime I have more excess $$ I up my auto savings transfer.

so like 5 years ago I was making 45k and going through nasty divorce where I was coughing up 3K every few months (still have no idea how I managed that!)

when I got raise to 55k + yearly bonus I started to auto save, and then would put all my bonus and tax refund into savings.

then kids daycare went down with older kiddo starting school (1300 down to 1K) so I started putting that into savings.

Then about a year ago daycare went down to 700 with younger starting school, and I got a new job making 82 (I didn't pay for ins before, and I don't get bonus...so its not as huge of a hop as it looks) so my auto save went up again.

I'm basically still living on 45-50 a year for me and the kiddos, and everything else is going into savings.

If I LIKED my house and ex didn't still own half of it, i'd be paying mortgage down early. I loathe the house (didn't want it in the first place but after looking at over 160 houses...not kidding, this was the ONLY one he was like "eh..its ok" on) and its worth about half of what is owed....and it needs probably 40K of work right now.

I'm currently on a 4/5yr plan of savings and hoping I can buy a new house that I actually like. planning to sell or rent current house depending on the situation then. but I feel like I need to have 6-8m expenses, 20K per house (x2) for repairs, a year of taxes on both houses (6-7k), 3m mortgage on both houses (6k), and 20% down on new house.

I will admit to splurging about once a quarter the last ehh....2 years? I bought a new fridge and dishwasher, a freezer, a dyson, a lovesac for the kids, new flat screen tv to replace the huge 32" CRT one, a serger....etc.

so probably a bit above the 45-50k i've been living on ;)

oh, and everytime my savings is above 10K right now (i'm thinking I may make it 5K soon) I move over the extra cash to my chase investment acct. I've earned 1500 in interest since may!

[LeighPF]

I agree with Baysica, don't absorb it all into your daily living. The only thing I would consider adding in that department is a very fixed amt on something like a monthly date night with sitter. I would also consider taking one month of that money (the first $1000) and spending it on a nice weekend to celebrate.

This is my family, probably end of this year, beginning of next year, with slightly different age kids.

The problem with putting in into your morgage is that then it is spent and you have no flexibility with it. I like having some capital to work with.

a) Look at the emergency fund. Is it healthy, make you feel comfortable.

b) I would look at my retierment savings and make sure we were maxing out our tax benefit, employer matchups etc. There is no borrowing for retirement. At least CPP is solid.

c) Are the twins going into childcare next year? Is that going to make a dent in your monthly spending for a few years. Do you want a cushion?

d) Savings for renos, other projects that are high priorities for you.

e) Then I would pay extra on the house.

[colsxjack]

Ok. So we decided to not put extra into our mortgage. We pay 3.9% interest and want to do a lot of updating and renovations and we want to move with 6-8 yrs.

We are going to bring the kids to visit family across the country this summer.
So our short term decision is to put some into savings for the summer trip, so we can do it fully out of cash. And put the rest into savings for house.

We do not have the best/biggest retirement savings. But we are saving steadily. We are also saving a small but steady education fund.

We do not really have emergency fund. But both of our careers are very, very secure.

After the trip in the summer, that part of savings will then go into an emergency savings fund.

Thanks for all the thoughts

[LoveOurBabies]

An emergency fund is not only to cover job loss - It also covers emergency replacements as well (so that you don't find yourself back on credit). Think of (God forbid): fire, flood, 3-4 appliances dying within a short period of one another, renovations you did not expect, car accident, accident in general..

I'm not trying to worry you, I guess it's more of an 'ensure you're prepared for unfavourable situations' message. With that extra $1000, I'd also get salary continuance insurance set up (if you havent already), as well as life insurance (enough to cover the outstanding amount on the mortgage).