What would you do if you were handed $10,000 tomorrow? $20,000?
The easy default answer–if you spend time in the personal finance world–is to pay off debt and save the rest.
But is that the right answer?
When my mother-in-law died, we inherited a little bit of money, a house that hasn’t been updated since the 60s, and a new-ish car that still has an active loan.
We also have about $16,000 in credit card debt and a small mortgage.
The Dave Ramsey answer would be to pay off the card at all costs and worry about the inherited house later, but that seems off. If we modernize the house and fix the things that are broken, we have a mortgage-free rental property. Our local rental market is strong; we should be able to clear $800 per month after expenses.
Is the right answer to pay off our card and scrape to get the house ready or should we fix up the house and use that new income to pay off the card?
My wife has also inherited an IRA that–due to its status as a Beneficiary IRA and the fact that there have been disbursements–has to be drained within 5 years. It’s not huge. After taxes, it’s about the size of the car loan. Should we make the $200/month payments, or cash out the temporary IRA and make the car loan go away immediately? Should we cash out the IRA and open one for my wife?
Although the cause was sad, these are good problems to have. If we manage this right, we’ll be more financially stable than we would have been for decades, otherwise.
I want your opinion, please.
2 questions:
1. House or credit card?
2. What would you do with a $10,000 IRA that has to be cashed out over the next 5 years?
Do you need the car or could you sell it, pay off the loan, and use whatever is left over to fund some of the remodeling costs that you want to do? This would let you use some of the $10k to cover whatever else is needed there, and would likely also let you pay off a chunk of the credit cards.
Or if you do keep the car, is there another car it’s replacing that you could sell and apply the proceeds as stated above?
Either way, I think you have the right approach. I just think that you should use at least a percentage of what you got towards the credit card. I typically have a ‘rule of 25%’ where 25% goes toward paying off debt and the rest is applied as I see fit (but not limited to 25%). Something to consider.
I’m so against credit card debt that I’d try and get that gone ASAP — whether that’s using the IRA or not. But you’re right, if using the cash to pay off a debt means that you have to use debt to fix up your house, then it makes sense to pay for updates with cash and pay off the debts with rent.
So we’re in a similar situation. We got about $25k in life insurance from my MIL’s passing. We also got her condo (not paid off) and the rest of her estate.
Due to probate laws, we can’t sell the condo (if we do sell it) until after probate is done. We currently have the option of using the remaining money from her estate (and a couple grand oflife insurance money) to pay off the mortgage on her condo and keep it as a rental. (There are currently renters in it). Or we could sell it to our renters.
In addition, the life insurance money is enough to pay off my graduate student loans. Selling the condo would give us enough to pay off my undergrad loans. It’s all so tempting.
For the moment, though, we’re not paying off anything. We did trade in a car and buy another one with cash, but we’re mostly holding on to the money because of other priorities in our lives.
If you want to be landlords, want an investment property- than I say invest the money house to rent it out. You will make more money on that (with no mortgage) than you’ll be paying in credit card interest, so in the end, you’re good.
But if you’re ambivalent about wanting to be landlords, it’s probably better to sell the house for what you can get and use the money to pay off debt, or invest in higher earning funds.
As for the IRA- what does your wife’s retirement savings look like currently? If she’s solid on her own retirement savings (not just yours) take the IRA and pay off the car. If she’s behind on retirement savings, it’s probably better in the long run to keept this money as retirement savings for her.
So tough to know what to do without all of the variables? How bad of shape is the house in and could it be rented as is? Is the car worth more than the loan? If you could rent the house out now I’d say rent it as is and pay off the CC debt, sell the car and pay off the loan and use the IRA to fix up the house. It really depends on all of the variables though.
I would make the very basic, necessary fixes to the house to get it rented. Then use any remainder, the IRA, and the rent to pay off the credit cards.
Shanendoah is right. Don’t rent out the house unless you are sure you want to be landlords. Don’t be dazzled by that $800 a month. Owning rental property can be a major headache, and even though I know you can spot a deadbeat at 50 paces, stuff happens and good people sometimes turn into squatters. Are you familiar with Minnesota’s landlord and tenant laws and rights? Do you want to spend what little free time you have fixing somebody else’s leaky faucets and broken water heaters? All I’m saying is, think about it.
I’d buy the house, but only because I believe the benefits of homeownership in my market, would far outweight paying off the credit card. I would, however, use the funds to build up my own retirement savings.
You should create a discounted cash flow, to see if you’re better off selling the house or renting it. $800 doesn’t mean much unless it is compared to the sales value of the house. The second part of that is what kind of additional return can you expect if you put money into the house.
Now compare the % return, after taxes and such, you expect to make on the house to the rate you’re paying on your credit cards. Would you be able to take out a mortgage on that house and use the equity to pay off your CC, then cover the mortgage at a lower rate with the rental income?
The same logic applies for the IRA – what is the rate on the car loan, do you save anything by prepaying? If not, I’d continue to pay the $200 payment using the IRA money. If it’s going to save you to buy the car outright, then definitely do that! Note that I have no idea what the tax implications are like on these decisions in the US.