Case Study: Growing a Money Mustache at Sea

I just got an interesting request for a Mustachian Makeover*. Here is our reader’s story:

Dear MMM,

I was wondering if you might want to do an analysis of some reformed spenders working hard on their stash but dealing with the repercussions of previous and lasting life choices (like a mortgage) in their newly reformed lives.

My husband and I have a large mortgage at 6.5%. It is also (cringe) interest only. We were paying a little extra on it every month, but I have since stopped and opted to invest that extra instead. My thinking was I could keep up with or beat 6.5%, and if anything terrible were to happen I didn’t want all our extra money tied up in a house that was still underwater. We save as much as we possibly can every month, including contributing to a 401K, $500 to each Roth every month, and additional savings. We live on a very strict budget in order to max out that additional savings.

We recently made a huge life change. We have a boat which we intended to live on after selling our house and while building a new one. Selling our house didn’t happen though, so instead we have rented out our house and moved onto the boat. We continue to save what we did before, but now additionally save the rent payment and the money that was being spent on utilities, cable and internet. It’s amazing how much extra money you save when moving to a smaller space!

Our house is under water. If we were able to pay the mortgage down by $100,000 we would be able to refinance at today’s lower rates and the rent would cover our new payment and then some. Instead, we’re stuck in an interest only mortgage with a balance that doesn’t move and rent payments that cover only about 70%.

Eventually we would like to move back onto land, probably in a different area. Our only other debt is our car payments – modest in comparison to old payments, but (I know) still not very mustachian. The rates are only 3.9% though.

What would you suggest is our best course of action? Should we put everything towards the mortgage instead of investing it? Or should we try to make our savings grow at a faster rate than the mortgage, and then later use it to pay the mortgage down and refinance? If we can eventually bring the mortgage payment inline with the rent, should we look into buying a smaller more practical home while continuing to rent the existing one, or should we move back into the one we already own?

———
Dear Lost at Sea,

First of all, congratulations on your new-found Badassity! Moving from what sounds like an expensive luxury house to a boat is a sign that you have what it takes to get yourself out of trouble very quickly, and then amass some serious riches for yourself in your new future.

From the sounds of it, your mortgage situation will never go away unless the house appreciates quickly, or you get it paid down to a level where refinancing is possible. The bad news is, housing appreciation is unpredictable and a $400,000 house would take 11 years at a 2% inflation rate to appreciate by $100,000. The good news is, a hundred grand is pretty easy to come by when you have two people working.

You didn’t tell me the price of your house, or the mortgage balance, but let’s assume it is a $400,000 house with a $400,000 mortgage. To refinance, you need to pay off at least $100,000 so that you have 20% equity to qualify for a good mortgage.

Current interest cost: 400,000@6.5%: $26,000 per year
Interest cost after paying down $100k and refinancing: $300,000 @ 4.5%: $13,500 per year
Savings: $12,500 per year.

So by investing $100,000 into your mortgage, you’ll end up saving $12,500 per year in interest. That’s equal to a guaranteed rate of 12.5%** on your payments – the best you will get anywhere in the world.

So I would suggest that you temporarily suspend ALL savings for this emergency – 401k, Roth, investments, piggybank, whatever, and put it straight into the mortgage. Transfer any liquid savings over as well, except for a small ‘Stash in case of emergency expenses. Every cent you put in is earning you 12.5%, so it is very exciting! Skip dinners out, skip driving on weekends, and just go crazy on that hundred grand. Plan all your rewards and future purchases for sometime after you reach that goal of getting this refinancing done. Also, we cannot predict when interest rates will rise, so the sooner you get it done, the better.

Next, if you have car loans, you probably have cars that are way too expensive for your current net worth. You could save an additional boatload of money by selling them both, and buying some nice 2004 models for $5000-$8000 each.  Toyota Corolla, Matrix, Scion xA, Nissan Versa, Honda Civic, even a Volkswagen Jetta or Golf  TDI – all great choices because of fuel savings and tying up only a small amount of cash.

Mr. Money Mustache feels that nobody with less than a million dollar net worth should even consider buying a new car (and even then, you must pay cash of course), and even then it must not be a car over $20,000,  and even then they must punch themselves in the face after making the purchase to acknowledge the unnecessary expenditure.

To answer your other question about the long-run housing choice – to answer that seriously I’d have to know about the size of the house, the cost, the location, etc. But to put it in my usual generalized and opinionated terms, I would say a couple with no kids should have a house no bigger than 2500 square feet (ideal size is 1500 sf), that costs no more than three years of their combined salaries put together (ideal ratio varies widely depending on your city). Instead of size, focus on quality, like big windows with nice views, open floorplan, big fancy kitchen with a nice island for entertaining people and cooking at home, in a walkable and bikeable neighborhood that will free you from car dependence. And of course, with a minimal or zero commute to work.  So you may indeed want to downsize and pick a new location.

As for renting it out vs. selling it at a loss – it is a good rental if the annual rent income exceeds about 6% of the current market value if you sold it. Or AT LEAST if the rent payments cover all the costs and you don’t mind being a landlord.

Once you get to this stage (or even sooner if you like), write in and tell us how you’re doing and we can tell you how to get the additional million dollars saved for a luxurious semiretirement for both of you.

I’ll admit this is a wide-ranging and highly detailed prescription. But hey, you asked for a Mustachian Makeover! If you follow it to its fullest, I guarantee you will both be retired, muscular millionaires with great happiness and health within 10-15 years, and Mother Earth will open her big blue watery eyes and wink at you as you sail your boat over top of them on a sunny summer Sunday shortly afterwards.

* The reader actually invented the term Mustachian Makeover herself, and said I could add it to the growing MMM dialect. Thanks, Lost at Sea!

** Note that even though we don’t know her mortgage amount, the actual return on the 100k invested is likely to be equal to, or even greater than the 12.5% listed, since the savings amount scales up with the ratio of current mortgage size compared to $100k.