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Author Topic: Question for the finance/mortgage people of the world
RivalOfTheRose
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(Simple Version: All numbers rounded)

Rival's Family: Wife, 2 Kids under 3

Rival's Plan: No more mortgage, pay for college

Rival's Debt: $200,000 principal on mortgage
Rival's Bank Balance: $200,000
Rival's Extra Secret Account Balance: $50,000
Rival's Mortgage Payment: $1500 per month

Yearly Savings: $20,000 (Split evenly between two incomes.)


Rival's question: Is there any reason why I shouldn't just pay the mortgage off instantly?

Pros:
1. Don't have to pay any interest.
2. Own the house outright, no bank leverage.
3. Proverbial freedom and weight off shoulders.
4. Can apply mortgage monthly savings towards retirement/college.

Cons:
1. Loss of all current savings.
2. Money voodoo like lowers tax rate, better off investing, yadayadayada...

Question: What cons am I missing?

The twist: One option is to have wife stay quit her job and stay home with kids for a few years. She would work again after that.

Pros:
1. More family time
2. Savings from daycare

Cons:
1. More financial responsibility on me
2. Tough to get a job in her field after a few years off.
3. Big loss of income.
4. No retirement or college savings.

Thoughts: I would absolutely love the fact if my wife could stay home with my children. But, the financial implications of that are scaaaary.

The rub: Two separate/entwined issues here. Paying off mortgage would allow greater financial flexibility. Would help wife stay home. The 'head' answer is to both keep working. The 'heart' answer is to have my wife stay home. I don't know if there is a middle ground. But we do need to make this decision sooner rather than later, and have already done a ton of thinking over it. That's where we are now, 50/50. I come to you Hatraqueros, for guidance.

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JanitorBlade
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I'd pay off the house, purchase another home, and rent that house out using the rents to pay the mortgage on my second investment property.

You then use the money you were applying towards your mortgage towards either,

1: Education fund.

2: Mutual funds, index funds, diverse portfolio investments.

I can't really run the numbers right now, but you're basically ripe to use your money to earn more money, and setup retirement. That's where my thinking would go.

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tertiaryadjunct
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Edit: ^^ My parents successfully did this, but without paying off mortgage #1 first. Of course things have probably changed since the 80's...

I know nothing about mortgages but I will say that everyone I know who has the power to pay one off doesn't do it. The "money voodoo" must be pretty powerful. (Though one of them put all her money into Madoff's ponzi scheme and lost her house. Eggs in one basket and all that.)

Mostly I want to ask why there is no 'Rival stays home' option. If you make about the same as her and your field is easier to get back into after a pause, it is also worth considering.

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scifibum
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You should probably consider the stay at home parent question separately from the pay off the mortgage question. It's pretty much a question of how much you value the benefits of that arrangement vs. the loss of income.

Whether to pay off the mortgage can be a more dry financial calculation - in other words, only do it if you can't get a better return by investing (taking into account whatever risks you are comfortable with). If you get a better return from investing, you're going to get that whether your wife is working or not.

One factor - it might be less costly to sell investments to pay off the mortgage later than it would be to re-mortgage the house in order to invest. This is ignoring risk to your original capital, of course. (But house values aren't guaranteed to be stable or rising, either.)

I would imagine it's worth consulting a financial adviser who ought to be equipped to model different scenarios for you without a lot of effort.

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TomDavidson
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If you have $250K in liquid assets that are burning a hole in your pocket, seriously, talk to a financial advisor.
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Orincoro
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Yeah, I echo Tom on that one. If you have a bank balance of 200k, and are easily saving 20K a year between you, there's a lot you can do with that money that might be better than sitting on it- including buying another property.

The financial voodoo involved in not paying off your mortgage is complicated, and usually not quite as important as people make it. However, there are cases in which paying it off is pointless.

For example, my mother owes 600k on a house worth upwards of 1.5M, but because there is so much equity in the house, and because she has so much money saved, her mortgage only costs something like 1.2% after the last time she refinanced. At that rate, the bank is essentially paying you to keep the mortgage. The interest from 600k parked in conservative investments pays for the mortgage and then some, so at the maturity of the loan, she will have the principle intact, plus the house. If she paid it off, she'd have just the house.

So if the interest rate you're getting from investments is higher than the mortgage rate, you're foolish to pay off the mortgage. The banking system is set up to favor people who have more assets. If you have money in safe investments, and it is enough to cover your mortgage, the banks are very happy to give you the best rate they possibly can on the mortgage- because they are confident that you will not default. For them, it's a very safe class of assets.

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King of Men
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Regarding Tom's point: If you get a financial advisor, make sure it's fee-only, no commission. Incidentally, I personally charge exactly what my advice is worth, which is its weight in gold.

It's not clear to me what your "pay for college" plan means. Do you intend to pay off an existing student loan, or to go (back?) to college with the 50k in your extra secret account?

Presumably your numbers are rounded off, but do keep some reasonable sum like 10k in reserve for emergencies - don't leave yourself entirely without a buffer.

quote:
So if the interest rate you're getting from investments is higher than the mortgage rate, you're foolish to pay off the mortgage.
Not necessarily true. There's such a thing as a risk tolerance. A man with wife and children might reasonably prefer the lower, but certain (ish), return of owning his own house. Note too that the imputed rent of being your own landlord is tax-free, which is not generally true of investment gains.

Speaking of taxes, if you haven't already done so you should start an IRA - Roth or traditional I can't say without numbers you may not be comfortable sharing.

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RivalOfTheRose
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"It's not clear to me what your "pay for college" plan means."

for my two children.... at least 15 years away

i have a 403B that I already pay into for my job (teacher)

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Orincoro
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quote:
Originally posted by King of Men:

quote:
So if the interest rate you're getting from investments is higher than the mortgage rate, you're foolish to pay off the mortgage.
Not necessarily true. There's such a thing as a risk tolerance. A man with wife and children might reasonably prefer the lower, but certain (ish), return of owning his own house. Note too that the imputed rent of being your own landlord is tax-free, which is not generally true of investment gains.

Speaking of taxes, if you haven't already done so you should start an IRA - Roth or traditional I can't say without numbers you may not be comfortable sharing.

A good point. As I said, at these amounts it can be a bit academic.

When you are talking about a larger amount of money, like 500k, the math might be more important.

Some napkin math: if you have a 500k investment account at 4% return and a 500k mortgage at 2% (just for kicks), then it would look like this:

The investments over a 25 year period would gross a return of about 850k. Net, something like 700 after capital gains (which you could avoid paying year on year by keeping it in a tax deferred account for example).

Now, if your mortgage holds at about 2% for the lifetime of the loan, also 25 years, then you will be paying only 120K (plus the 500K principle) in total interest, which is not too shabby.

At the end, you would have 700k, plus a house worth, one would assume, at least 650k.

That said, you've only made maybe 80k more than if you'd just dumped your monthly mortgage payments into investments over the same period, and I'm not even factoring compound interest on those investments- so the net result might actually be virtually the same.

Still, if you have the means to pay, and are reasonably young, why not keep the cash, and pay slowly? It is ultimately about risk, sure, but there is risk in your income as well. Cash is still cash, and you would have the flexibility of selling your home before the mortgage is paid off, and still having separate cash to live off of if needed. Plus, you could foreclose on the home if it got underwater for whatever reason, and still have your money.

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theamazeeaz
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Rival,

What's your mortgage rate? How much have you paid back so far?

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theamazeeaz
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quote:
Originally posted by scifibum:
You should probably consider the stay at home parent question separately from the pay off the mortgage question. It's pretty much a question of how much you value the benefits of that arrangement vs. the loss of income.

Whether to pay off the mortgage can be a more dry financial calculation - in other words, only do it if you can't get a better return by investing (taking into account whatever risks you are comfortable with). If you get a better return from investing, you're going to get that whether your wife is working or not.

One factor - it might be less costly to sell investments to pay off the mortgage later than it would be to re-mortgage the house in order to invest. This is ignoring risk to your original capital, of course. (But house values aren't guaranteed to be stable or rising, either.)

I would imagine it's worth consulting a financial adviser who ought to be equipped to model different scenarios for you without a lot of effort.

Paying additional principal is most useful in the early stages of the mortgage, or if you are paying PMI. If you want to halve your mortgage payoff time, figure out how much your principal payment is, and then add that amount to the payment.

One way to think of it is that a dollar of extra principal is worth $3-4 when your mortgage is new, but $2-3 later on, and a little more than a dollar by the end.

The best thing you can do is to look up mortgage excel spreadsheets. The simple dollar or get rich slowly has instructions on how to make your own, and doing that versus just downloading one will teach you more.

I took mine and I added two columns. One is called "regular extra payment" and the other is called "one time extra". The regular extra payment box is keyed to a field at the top that lets me fiddle around with alternate payment schedules. (this will make more sense when you actually make a spreadsheet. Every month, when I pay extra, I put what I did in the one time column and zero out the formula in the "regular" box.


If you think your monthly payment is too high, you can pay a bunch of money (I think 10kish minimum) and "recast" your mortgage, which will not save you any money at all, but let you have a lower monthly payment based on what you prepaid, and costs less than a refi.

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Geraine
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Pay the house off, be debt free.

The tax savings voodoo is just that. You end up spending thousands in interest to save hundreds in taxes. On a $200,000 mortgage at 5%, you would get a tax deduction of about $10,000. If you made $75,000 per year, that's about $2500.

So you can either pay $10,000 to the mortgage company in interest, or pay the government $2500 in taxes. I'd rather pay the $2,500.

Pay off all of the debt you have, and you still have $50,000 in savings. That's a nice emergency fund. You can then start saving for college for your kids as well as contribute more to your 401(k). Max it out every year if you can.

When my kid was born last year I started contributing a couple hundred bucks a month into a 529 plan. It equals out to $2,400 per year, but by the time he graduates high school he should have over $40,000 to help out with college. That's before factoring in market growth, returns, or compound interest. As we make more money we will likely increase the monthly amount as well.

For day care costs, if you are not contributing to a dependent care FSA through your job, do so if it is available. You can contribute up to $5,000 per year, and it is pre-tax. That should save you some tax money.

Having a parent at home is a huge plus when children are younger, so I understand why you are torn. I look at it this way: My wife and I both work but can then afford to save for things like college for my little boy. I'm lucky in that he stays with family while we are at work. The advantage that he will have when he is older though is that he may not have to work through college or worry about how he is going to pay tuition. (Or how I will pay for his tuition!)

It's a very tough decision, but for me I'd pay off the mortgage. Financial stability eliminates a lot of stress and focus more on your family.

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scifibum
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quote:
The tax savings voodoo is just that. You end up spending thousands in interest to save hundreds in taxes. On a $200,000 mortgage at 5%, you would get a tax deduction of about $10,000. If you made $75,000 per year, that's about $2500.

So you can either pay $10,000 to the mortgage company in interest, or pay the government $2500 in taxes. I'd rather pay the $2,500.

If tax deduction was the only upside of not paying off the mortgage, it'd be that simple. If you get a 5% return on $200,000 invested, AND a $2500 tax savings, it's less clear. Of course, a lot depends on what the investments are and when gains are taxed and at what rate - but there are scenarios where you're leaving money on the table by paying off cheap debt ahead of schedule.
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Geraine
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quote:
Originally posted by scifibum:
quote:
The tax savings voodoo is just that. You end up spending thousands in interest to save hundreds in taxes. On a $200,000 mortgage at 5%, you would get a tax deduction of about $10,000. If you made $75,000 per year, that's about $2500.

So you can either pay $10,000 to the mortgage company in interest, or pay the government $2500 in taxes. I'd rather pay the $2,500.

If tax deduction was the only upside of not paying off the mortgage, it'd be that simple. If you get a 5% return on $200,000 invested, AND a $2500 tax savings, it's less clear. Of course, a lot depends on what the investments are and when gains are taxed and at what rate - but there are scenarios where you're leaving money on the table by paying off cheap debt ahead of schedule.
Even then you lose money. Over 20 years at 5% on a $200,000 mortgage, you will end up paying $116,000 in interest on your $200,000 mortgage. That's more than 50% of the cost of your mortgage.
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dkw
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But if you invest your extra money instead of paying extra on your mortgage and get a greater than 5% return you will be ahead of the person who pays off the mortgage instead of investing.

Both of you will be ahead of the person who makes only the minimum payment on the mortgage and spends the rest of her/his money, of course.

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scifibum
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quote:
Originally posted by Geraine:
quote:
Originally posted by scifibum:
quote:
The tax savings voodoo is just that. You end up spending thousands in interest to save hundreds in taxes. On a $200,000 mortgage at 5%, you would get a tax deduction of about $10,000. If you made $75,000 per year, that's about $2500.

So you can either pay $10,000 to the mortgage company in interest, or pay the government $2500 in taxes. I'd rather pay the $2,500.

If tax deduction was the only upside of not paying off the mortgage, it'd be that simple. If you get a 5% return on $200,000 invested, AND a $2500 tax savings, it's less clear. Of course, a lot depends on what the investments are and when gains are taxed and at what rate - but there are scenarios where you're leaving money on the table by paying off cheap debt ahead of schedule.
Even then you lose money. Over 20 years at 5% on a $200,000 mortgage, you will end up paying $116,000 in interest on your $200,000 mortgage. That's more than 50% of the cost of your mortgage.
I don't think you are seeing what it is that I actually said.

Anyway, I hope Rival talks to someone who can walk through different options taking all the details into account.

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Orincoro
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quote:
Originally posted by Geraine:


Having a parent at home is a huge plus when children are younger, so I understand why you are torn. I look at it this way: My wife and I both work but can then afford to save for things like college for my little boy. I'm lucky in that he stays with family while we are at work. The advantage that he will have when he is older though is that he may not have to work through college or worry about how he is going to pay tuition. (Or how I will pay for his tuition!)

It's a very tough decision, but for me I'd pay off the mortgage. Financial stability eliminates a lot of stress and focus more on your family.

Oh man am I glad I emigrated to Europe.

1) My wife receives a parental allowance which actually discourages mothers from returning to work for 3 years (can be taken by fathers as well with the same conditions) 2) College is free, and students receive cost of living stipends in some cases, 3) health insurance is literally 500 dollars a year for an adult- and that's for zero-deductible coverage (with a 1 dollar surcharge).

It's amazing what you can get accomplished when you start with your goals and work backwards: "we want universal education... here's how much that will cost in tax money." "We want universal health care... here's how much every able person must pay."

And the state finds that paying each parent about 400 dollars a month in parental support is cheaper than providing or regulating or otherwise supporting day care for small children (and in this economy, 400 dollars is probably closer to about 1000 in the states). [Smile]

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Geraine
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quote:
Originally posted by dkw:
But if you invest your extra money instead of paying extra on your mortgage and get a greater than 5% return you will be ahead of the person who pays off the mortgage instead of investing.

Both of you will be ahead of the person who makes only the minimum payment on the mortgage and spends the rest of her/his money, of course.

True. I just look at it this way. If I have no mortgage, I have $1,3000 that I can use to invest. In addition to the $20,000 that I save every year. That's over $35,000 per year that I could invest. 6 years and I've already invested $200,000 without having to pay a dime in mortgage interest to the bank.

I'd get with a financial planner though. Based on the situation they'd be able to help the most.

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RivalOfTheRose
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The guy who runs my 403b investment says paying off the house is a great idea, especially if I reinvest most of the monthly amount into 529 college plan and more into the 403b.

The idea of only having to pay for utilities, taxes, and insurances seems VERY appealing. I think this is what I will do no matter what happens with my wife staying home.

More info on that however:

As it stands now, we save about $20,000 per year. Here are some different scenarios. I put them in sort of an order of appeal, but one and two seem almost interchangeable...

1 - If she continues to work and we reinvest everything, pay off the house, that number stays about the same... just we get to pump new funds into the said investments.

2 - She quits and stays home and we pay off the house. We only save about 10,000 per year, and no future savings until she goes back to work in a few years. I doubt however, she would easily be able to find a suitable job with similar pay as she does now.

3 - She continues to work and we don't pay off the house. This is pretty much the status quo option. Keep saving per year, but no investments, unless we divert more funds to those purposes.

4 - She quits the job and don't pay off the house. We go into debt 10,000 per year until she works again. No investment options.This doesn't seem like a very wise choice.

Conclusion:

I think no matter what we will pay off the house. Gets us with completely no debt, room to grow, and room to invest. Most importantly, gives my wife the option to stay home if we decide that's best. Paying off the house seems like the only way to make that feasible.

The head says to pay off the house and keep us both working, for anticipated financial stability for the rest of our lives.

The heart says to have my wife stay home with her children when they are young, but at the risk of managing finances more difficult.

Disclaimer: Obviously there could always be some financial disaster or windfall that could change things drastically either way.

Final thoughts: I don't think that out of options 1 2 or 3, that we could make a 'wrong' choice. 4 sucks. There are many other smaller yet still important factors that will go into this decision, but I feel like this is a pretty comprehensive view of the 'big picture'. Thank you all for the input, it has been helpful in evaluating this big decision.

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dkw
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Your presentation of #4 is prejudiced against it. You don't go into debt with that option, you use the money you didn't use to pay off the house as income replacement. Living partially off savings is not the same as going into debt.
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theamazeeaz
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Also, you still haven't told me the *original* loan amount and your interest rate, only that you owe 200k.

The last third of your loan you are paying so little in interest, that you aren't saving much by paying all of your mortgage off.

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Dogbreath
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*nods*

A 5% annual return on that $200,000 invested would cover that $10,000 a year in scenario 4. Or you could just take half of your savings and put $50,000 each into the 529 *now* and let it accrue interest for the next 15 years until your kids start college, your wife could quit her job and you could eat up $x amount a year ($10,000 in the worst case scenario where you're just keeping it in a bank) of the other half of your savings for the next 5 years or so, and still have a lot left over by the time she goes back to work, at which point you can start making 529 contributions again.

Putting $50,000 into a 529 now is actually a better deal than putting $10,000 a year over the next 5 years anyway in terms of accruing interest. And you'll probably see much better tax returns with the drastically lower income from your wife not working.

ETA: upon looking it up, it looks like there is a gift tax on contributions over $14,000/year to each 529, so you'd have to space that $50,000 out over 3 and a half years. Still probably a better deal, especially in terms of just transferring it from one investment to another.

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RivalOfTheRose
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We refinanced the mortgage on: 09/08/2010

Loan amount: $269,173.00
Payoff date: 10/01/2040

Interest rate: 4.625%
Current payoff amount: $220,073.69

Any other info that would be helpful?

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theamazeeaz
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Nope. That's enough. Excel spreadsheet fun time! ::tap tap tap::

I can see that you've already pre-paid enough extra money to knock of over $25,000 worth of principal, and because of this, every month, you are paying $100 less in interest than you would be otherwise each month. If you continued to make the standard payment of $1383.92, every month, on time (and not any extra, you are looking at paying this off in 2036. Doing this has already dropped *at minimum* ~$50k from your mortgage. I don't know when you've made these payments, it could be more. If you paid $400/extra per month, every month, you've saved 95K (which will have you paying off your place in 2029, btw).

You are still flushing ~$850/month down the toilet in interest, though every minimum mortgage payment you make adds $2.70 to the principal (and rising- see my email analogy in the other thread).

4.625 isn't an awful rate considering, and it's actually very decent for a "safe" investment, though S&P 500 gets you better (albeit tough to stomach) over 10 year+ periods. Even if you only average 4.75% in investments, you win handily over paying a 4.625% debt.

The 179k mark is where you start paying more principal than interest each month, and by the time you hit 100k, you will only be paying $400 in interest (you are also 6 years out, and by that time your wife will probably be back at work).

I think that's the point where you really stop benefitting from paying extra, especially when you've got other ideas for the cash (say, paying cash for a vehicle, remodel, investments could do better.

As far at the mortgage vs investments go, you are never obligated to make a single choice. That is what allocation is for, and you can pay some of each. I think you are still in the realm where paying off extra makes a difference, though investments worth more than 4.625% will always come out ahead

Anyway, as Tom said, if you don't know how to invest $250k, talk to someone who is actually qualified (fee only, please).

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RivalOfTheRose
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You have been pretty on point with your number guesses! You really didn't have to put this much time on my behalf, so thank you greatly.

We have been putting in an extra 200-300 per month, and with yearly one time 'full payments' (principle only) when we get our tax refund.

Also, did some research on the NJ 529, called NJBEST. I only need one account for both children, the funds are transferable with no penalty. But, like you said, there might be a limit to the 'gift' before tax. So starting two accounts might be worthwhile.

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Geraine
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Love the 529. My parents had been putting a little money each month into an account for each grand kid. I asked them if they wouldn't mind just putting it into the 529, which they are. So now the little guy has both his parents and his grandparents contributing.
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theamazeeaz
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quote:
Originally posted by RivalOfTheRose:
You have been pretty on point with your number guesses! You really didn't have to put this much time on my behalf, so thank you greatly.

We have been putting in an extra 200-300 per month, and with yearly one time 'full payments' (principle only) when we get our tax refund.

Also, did some research on the NJ 529, called NJBEST. I only need one account for both children, the funds are transferable with no penalty. But, like you said, there might be a limit to the 'gift' before tax. So starting two accounts might be worthwhile.

They aren't guesses once you gave me the loan length, interest rate, start date and balance. The only thing up in the air was when exactly you paid off the extra money.

Fussing with this particular spreadsheet for my own mortgage is a favorite procrastination hobby of mine. [Cool]

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TomDavidson
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Nerrrrrrrrrrd.
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dkw
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quote:
Originally posted by Geraine:
Love the 529. My parents had been putting a little money each month into an account for each grand kid. I asked them if they wouldn't mind just putting it into the 529, which they are. So now the little guy has both his parents and his grandparents contributing.

For calculating future financial aid eligibility it would be better for the grandparents to open a separate 529 in their names with the grandchild as beneficiary. 529's opened by the parents are counted as parental assets (which is still better than an account in the student's name, but grandparent's assets aren't counted at all.)
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msquared
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It is what my parents did for all of their grandkids and it seems to have worked just fine.
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RivalOfTheRose
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Hey msquared! You might also know me as Vesuvio Monteverdi!

Good tip dkw

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