Divvying up savings

[RosieTR]

DH and I are near to paying off one of our houses, which should yield about $700/mo extra based on the last couple of years of history of rental income minus expenses. There are two major things we should be putting that money towards: one is our current house (~$140K mortgage) and the other is a newer car (mine is 12 yrs old, goal might be about $20K). One caveat with the house is that it's upside down by a good chunk ($40-50K by Zestimate on Zillow). We have been mildly accelerating payments on it but were concentrating on the other house following the debt snowball method, since the mortgage was much smaller. The big mortgage is a little over 6% and as far as I can tell we can't refinance since we have negative equity despite excellent credit. So my question is, what are your thoughts on divvying up the savings? Prepaying the mortgage would "earn" 6+% and since we don't want to end up in the house for the long term we'd like to be able to sell it if the opportunity arises. OTOH, I do kind of need a car and would rather prepare now to potentially buy one in a few years if need be. I kind of don't like the idea of dipping into the E fund for a car since having a separate account would give me a framework for what car to look for when the time comes: eg if my goal is $20K but the car dies when I have 10K saved, I'll buy a car that costs $10K. If I don't have a separate car fund, then it's like how much of the E-fund should I use for a car? As far as the savings though, 1% is about as good as it gets earning, so I'm trying to balance that too. Anyway, thoughts are appreciated.

[kib]

I'd just shoot for replacement cost on the car, say $6,000, and put the rest toward the mortgage, assuming your emergency fund is already taken care of.

[Terri]

The deciding factor for me would be how much liquidity (emergency fund and other accessible savings and investments) you already have. Strictly by the numbers, 6% return by paying the mortgage is better than 1% return as savings for a car. However, because you are not able to refinance under any circumstances, anything you pay on the mortgage is then not available. If there was some sort of disaster and you needed immediate funds, where would you get them?

If you are comfortable that the emergency needs are covered, I'd pay down the mortgage with a goal of getting it to the point that you no longer have negative equity. But, if you really want to save for a new car, you could do some type of split, like an extra $200 per month on your mortgage and $500 per month in a savings account, will give you $6K towards a car by the end of the year.

[The Storyteller]

Thoughts:

If you don't have an emergency fund (or sinking fund or whatever you want to call it) for the rentals, you might want to build up one of those. I would want my rentals to pay for their own problems. That's the approach we have taken with ours.

$20k is more car than you probably need. Want is a different thing, but you can get a very nice, reliable used car for $5k or $6k.

I would split the extra $700 a month between the two goals once the EF is built. Maybe $300 a month for the car savings, $400 toward the house. Once the car is purchased, put it all toward the house. It's important you get that equity headed in the right direction. The sooner you are right-side-up, the sooner you will have the freedom to move if you want.

[RosieTR]

We have an emergency fund but it's sort of a catch-all for anything that comes up. I suppose the heart of the matter is that I'd like to separate out a few things to specifically save for, rather than just one big pot of money whose definition is "emergency". It's good to have some in such a fund, but I think I would ultimately be more satisfied to have saved specifically for a car (or any specific thing). Otherwise I wind up feeling sort of guilty for spending X on something that I could have spent some smaller amount, even if I actually like X a lot. For example, we did this for a big trip and I was way more relaxed on spending during that, and thus had more fun than if we'd just decided to go and taken the money out of the amorphous emergency fund. I don't think we even spent all we had saved for it, but I wasn't stressing out about this dinner or that hotel room because I knew we'd already saved specifically for this and were supposed to use it to have fun. Having a smaller initial goal for the car makes sense, then later I can throw little bones to it (like maybe a set amt every time I ride my bike to work or something) so to get a few more bells and whistles in terms of age or whatever when I do need to replace the car. The car may last 2 years or 10 but I want to be happy with going to a seller with whatever amount I have (or less) and buying something I like and then enjoying knowing I worked to save for it. Maybe that makes more sense? Anyway, thanks for the replies.

[Jonathan]

Making the assumption you have money set aside to fund repairs and vacancies in the rental (if you don't, you need this first to maintain the business):

The method/location of saving the money can be totally different than the notional use of the money. There's nothing wrong with having your e-fund account also include the savings for a car as long as you are tracking the different "funds" within the account separately. My credit union even allows a savings account with "sub accounts" that you can designate money go into if you want the "discipline" imposed by the account holder; can your bank do something similar?

However: If you took the whole $700/month and prepaid, how long would it take to pay off the mortgage? Can you keep the car running long enough to do that?

If so, consider that as an alternative although it's a calculated risk. Even paying for repairs costing more than the worth of the vehicle can be a good strategy if the vehicle is otherwise reliable. With the mortgage paid off, then saving for a new car will be a short process. We've managed to keep my truck going 22 years (and hopefully a few more). Yes, it needs $500-$1000 a year to keep going, but I'd rather pay that than spend the time to find a new vehicle and run the risk of getting a lemon. We only have 1 vehicle, so reliable is far more important to me than condition or payment status.

And if you go down this path only to have the car die early, a car loan isn't a bad thing since there is an asset to back it up *and* you have that $700/month to pay the loan with. You just have to be careful to only buy as much car as you need. Plus, you can put any extra accumulated against the cart loan, retire it early, and then go back to prepaying the mortgage.

[RosieTR]

9 years to pay off; 3 to become un-upside-down more or less. We are hoping not to keep this house, though, so full payoff isn't necessarily the goal. If we want a rental property we'll look closer to where we'd like to eventually live: near our other house. The $700/mo is an average based on income minus expenses for the last 2 years of renting that house out-it'll be up and down I'm sure. I may wait a couple months to rejigger our monthlies before I decide, since we were paying more than the yield each month before.

[Urchina]

If you don't want to keep the house, I would hesitate to pre-pay the mortgage. Why tie that money up?

I'd give yourself a good emergency fund for each rental (six months' expenses is what I've heard), beef up your personal emergency fund, and then sock the rest of it into that car fund you mentioned.

As far as targeting savings goes, we find ING Direct insanely easy. We have several targeted savings accounts there (sub-accounts under one account number), individually labeled, all earning the same percent, and we automatically transfer money into them each month. Doing this, we've saved for down payments, cars, emergencies, vacations, college -- you name it. It's been great.

Good luck!

[Jonathan]

If you don't want to keep the house, I would hesitate to pre-pay the mortgage. Why tie that money up? So when you go to sell it, you aren't paying to sell it? Also, interest is front-loaded on a typical mortgage, so the longer you keep paying the minimum, the more money per month you're losing in interest paid.

All that said, since the payoff is likely to not happen before the car dies, I'd suggest build the "car fund" to an appropriate level (you have to do some thinking about what you need vs. want in a vehicle to price them out), then start prepaying. Who knows, maybe the car will last 9 years; but it's better to plan for it.