Pay down mortgage or save?
Readers provide their answers to our Request for Recommendations: Pay down their mortgage or save for retirement? What should the family do?
Two weeks ago, Moneywise presented a composite family case (Mrs. And Mrs. Case) to the readers of The Royal Gazette with the challenge — how would you handle their financial dilemma?
Composite scenario: The family has received a small legacy. How best to use this windfall? Their economic outlook is uncertain; one spouse’s job is in jeopardy; the mother-in-law needs their financial assistance to care for herself and her rapidly depreciating property; the family is struggling with their own mortgage payments and private school fees, wishing they could be less stressed and more financially carefree.
It was wonderful to see that four individuals responded in the comments section. My sincere thanks to Mike, Jeff, cake4all and Really who took the time to prepare thoughtful, practical answers for this family’s financial problems. The original article, the detailed family composite case, (and the readers’ responses) is available online at Royal Gazette dated May 05, 2012. http://www.royalgazette.com/article/20120505/COLUMN07/705059995
Here are my thoughts (not specific recommendations as this column is not to be taken as personal financial advice). Some correlate directly with these readers, while others do not. Many years of a cross border financial planning background in assisting clients with traumatic financial situations has made me more realistic, less hopeful of a quick economic turnaround, and to put it bluntly, quite cynical of seeing any positive changes for a long time. I’ve lived long enough to experience more than one horrific recession. Yes, one particular economy (years ago) did recover — more than six years later.
With that long-tailed projection, this family needs to proactively move into cash restriction mode to preserve their economic independence.
1. Immediately, put a financial survival budget in place. Do not spend — except for absolute necessities. This means no vacations, no manicures (as one reader suggested), no credit card charges, no treats, no junk food, no extras. It will not be easy; it may be a huge obstacle to family harmony. It has to be done. Mr. Case, who is fifty years old, cannot begin to contemplate the alternative, having to start over on the home ownership ladder. They must keep their home. Statistically, when comparing of renting as a tenant versus owning a home using one of the many calculators (available on the web at many real estate websites) there is only one winner. Ownership.
2. Be consistent. Continue to reduce the mortgage. Make extra principal payments with some of the liberated financial survival budget cash above. Try to negotiate a lower monthly payment with your lender, but be forewarned that in this environment, the lender may not be terribly receptive to revising your payment terms- bearing true to one reader’s commentary that the greater the equity in the home, the better your financial position. The goal is to balance the accelerated pay down of their mortgage with the equally important goal of building a large cash buffer. Readers Mark and cake4all suggested a consolidation sale of their home with their mother-in-law’s property. This may be doable, but must be considered carefully given the current price depreciation of real estate along with the glut of unsold property on the market.
Additionally, if Mom’s property is sold (at a less than optimum price), she will be completely reliant on them for her financial and physical well-being. She may not want that — most mature individuals are fiercely independent. Mom will need most if not all of her assets for her own extended elder care. Best to cosmetically touch up and rent the property, as suggested by the readers, to temporarily increase cash flow. Mom’s property, as a potential rental unit, is up against stiff competition, with more than three hundred rental units available online listed in one local publication. Columnist Larry Burchall had an even better take on the enormous number of vacant apartments in a recent article last week.
3. Debt versus liquidity. Don’t over accelerate debt reduction. Be careful of the land-rich cash-poor syndrome. If all extra cash goes on the mortgage, any crisis could leave the family financially strapped. No bank is going to give you an equity line in this environment, particularly if your job is on tentative ground. And, lenders do know what gives in the employment market.
4. Hoard Your Cash Buffer. Do not buy into the generic planning mantra of three — six months of living expenses. This is not advice, it is generic marketing vapourware. In poor economic community conditions, even eight — twelve months is not enough. The family needs to prepare for unemployment situation that could last two to three years (2-3). A three year cash buffer for living expenses needs to be accumulated. No scoffing, folks, we have heard personal stories already from people unable to find a job, still unemployed more than two years out.
5. No investing. All remaining cash needs to be hoarded. No additional money should be placed into capital markets. The family cannot afford losses of any kind, nor can they cope with managing a situation where their investments are tied up in restricted distributions, meaning they cannot take their cash out on a normal redemption sale.
Investing for hoped-for-large equity appreciation in the future will only add to their current emotional distress burden, if the market tanks. Investments are not guaranteed.
6. Mr. Case must not quit his job — under any circumstances until he has another one with an equally if more financially solid company. Yes, he feels he is on shaky ground, but that regular salary deposit (and those good medical benefits) is still appearing each and every month. Lose your job, lose your health insurance. Bermuda is in an unfortunate, disastrously unique situation where the job market is shrinking. Those multiple flexible job choices are no where near as plentiful, while the good jobs have many applicants in stiff competition. If anything, to add more to the family pot (and stress), one of the Case spouses should be looking for a second job.
There are a number of additional planning items that the Cases need to address, that focus on longer term financial security. We will cover those strategies in the next follow-up article.
After reading this survival strategy, there isn’t much room for sentiment, emotional feelings and stress relief. The commentary may actually be considered quite heartless by some, but one must consider the alternative — that could be even more devastating. Again, a reader picked up on approaching the problem with a new mindset — focus on changing the way that you think about not only money, but what is most important in your life.
Martha Harris Myron CPA PFS CFP (USA) TEP is Director of Tax Services at Patterson Partners Ltd and a professional member of the American Citizens Abroad Tax Advisory Council. http://www.aca.ch Patterson Partners Ltd. provides of integrated cross-border tax, estate, investment advisory and related strategic planning services through entities in Bermuda and the United States. For additional information, please contact firstname.lastname@example.org or call 296 3528 http://www.patterson-partners.com
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