Should I pay off my mortgage, begin retirement savings, or build my emergency fund?

Question

My Goal

I am trying to calculate how best to apply my income to my various goals. For the sake of simplicity, I'm interested in the balance between three specific goals:

1. Paying down my mortgage
2. Building my emergency fund
3. Saving for retirement

My Situation

I'm a 27-year old male supporting a wife and two children. I make around $90k annually ($72k after payroll deductions such as taxes and insurance). I have no credit card debt or student loans - the only consumer debt I have is a $4,000 car loan with a 3.25% interest rate, which I am paying $200/mo on.

My Mortgage

I am almost four years into a 30-year, $235,000 mortgage with a 3.75% interest rate. I have made about $10,000 in extra payments in the last four years, with a current balance of $206,000. I am paying $200/mo in PMI, which will be removed in two years if I continue paying at the current rate (an additional fifteen months if I cut back my payments to the monthly minimum). This is an FHA loan, so I will not be able to remove the payments earlier than the five-year mark.

We've done some significant remodeling, and I believe that after our most recent project the town placed out tax evaluation at around $285,000. For whatever it's worth, a couple of online calculators estimate my home to be worth $300,000.

At the moment, I am paying an extra $300/mo towards my principal balance. My current plan is to keep paying at the same rate when the PMI is lifted, which will leave my paying $500/mo over the required monthly payment.

Based on my amortization schedule, and assuming my insurance and taxes remain the same, I can:

• Make minimum payments from October 2015 to November 2039, extending my PMI by 15 months ($3,000) and paying $110,000 in interest.
• Continue the extra payments ($300/mo) until my PMI drops out in November of 2017, then make minimum payments until July 2038, paying $100,000 in interest.
• Continue the extra payments ($300/mo) until my PMI drops out in November of 2017, then keep paying at the same level (now $500/mo) until April 2030, paying $60,000 in interest.

My Savings

I am currently allocating $100/mo into a designated Savings category on my budget spreadsheet. The balance currently stands at $10,000, but it has been more of an 'undesignated and mostly unused' fund than an 'emergency' fund. That money is currently sitting in a High-Yield Savings Account, with a 0.90% APY.

I also have a $7,000 Fidelity individual investment account, which was opened for me as a child by my grandfather and turned over to me when I became an adult. I have neither added to or withdrawn from that fund, but mentally I have marked that money towards a future home project (e.g., kitchen remodel).

My Retirement

My efforts up to now have been mostly focused on my mortgage, so I do not have any retirement-specific savings or plans.

My employer contributes 9% of my annual salary into a retirement plan, which I will be vested in after three years of employment (I have been here for a little over a year). The employer does not offer any kind of matched retirement account.

My Question

Without straining my budget, I could fairly easily shift around roughly $500/mo in "extra" money to apply to one or more of these goals. Currently, $300 is going towards my mortgage, $100 is going towards savings, and $100 is going towards extra car payments and various "plan-ahead" funds.

When the PMI is removed from my loan in another two to three years, that will free up another $200 (the $200 going towards the car payment now will be redirected to saving for the next car).

How could I best direct that money?

Answer 1

Welcome to Money.SE. I will say upfront, Personal Finance is just that, personal, and you are likely to get multiple, perhaps conflicting, answers.

Are you sure the PMI will drop off after 2 years? The rules are specific, and for PMI, when prepayments put you at that 78/80% LTV, your bank can require an appraisal, not automatically drop it. Talk to the banks, get confirmation, and depending what they say, keep hacking away at the mortgage.

After this, I suggest jumping on Roth IRAs. You are in the 15% bracket, and the Roth will let you deposit $5500 for each you and your wife. A great way to kickstart a higher level of retirement savings.

After this, I'm not comfortable with the emergency savings level. If you lose your job tomorrow (Funny story, my wife and I lost our's on the same day 3 years ago) and don't have enough savings (Our retirement accounts were good to just retire that day) you can easily run out of money and be late on the mortgage. It's great to prepay the mortgage to get rid of that PMI, but once there, I'd do the Roth and then focus on savings. 6 months expenses minimum.

We have a great Q&A here titled Oversimplify it for me: the correct order of investing in which I go in to more detail, as do 4 other members.

I am not getting on the "investments will return more than your mortgage cost" soapbox. A well-funded emergency fund is a very conservative bit of advice. With no matched 401(k), I suggest a balance of the Roth savings and prepayments.

From another great post, Ideal net worth by age X? Need comparison references you should have nearly 1 year's salary (90K) saved toward retirement.