After a string of steady increases, mortgage rates fell this past week — a mixed blessing for the fragile U.S. economy.
The lower rate on a 30-year fixed mortgage is a relief for home shoppers who have been watching rates climb, but it’s also a sign that a recession could very well be around the corner as the market slows.
Rates tend to mirror 10-year Treasury yields, which have fallen as investors seek safer, more stable assets in the face of higher inflation and slower economic growth.
“Rising prices are eating into consumers’ paychecks, leaving many Americans with less money for discretionary spending,” says George Ratiu, senior economist with Realtor.com.
“In addition, with inflation outpacing pay raises, most workers are seeing their income fall behind, further straining the finances of buyers who are also facing higher borrowing costs.”
30-year fixed-rate mortgages
The average 30-year mortgage rate fell to 5.70% last week, down from 5.81% a week previous, housing finance giant Freddie Mac reported Thursday. A year ago at this time, the 30-year rate was averaging 2.98%.
“The rapid rise in mortgage rates has finally paused, largely due to the countervailing forces of high inflation and the increasing possibility of an economic recession,” says Sam Khater, Freddie Mac’s chief economist.
“This pause in rate activity should help the housing market rebalance from the breakneck growth of a seller’s market to a more normal pace of home price appreciation.”
Austin real estate agent Lilly Rockwell says the market has already started favoring buyers and that she just helped a client negotiate a purchase for under list price.
“It’s fabulous. Finally. Tons of choices, very little competition,” she tweeted Thursday.
She’s also been advising clients to ask for seller credits — a cash payment the seller gives the buyer at closing — to help them buy down their mortgage rates.
Buying down your mortgage rate means making an upfront payment to your lender to reduce your long-term interest costs, and seller credits can help cash-light buyers take advantage of the option.
“I plan to deploy this strategy myself on a listing I have coming up next week and provide some rate buydown information to just proactively address concerns about interest rates,” Rockwell said. “It’s crazy how quickly the tables have turned!”
15-year fixed-rate mortgages
The rate on a 15-year fixed mortgage was averaging 4.83%, also down from the week previous when it averaged 4.92%. Last year at this time, the rate on a 15-year loan was around 2.26%.
Aside from a few exceptions, rates have been rising for most of 2022 following two years of record-low levels. They took a particularly sharp ascent in recent weeks as the Federal Reserve began raising its benchmark interest rate to curb skyrocketing inflation.
Still, analysts say it’s important to keep the recent spikes in perspective.
“Although rates are significantly higher than last year, they are still historically low, remaining below 6%,” says Nadia Evangelou, senior economist for the National Association of Realtors.
5-year adjustable-rate mortgages
The average rate on a five-year adjustable-rate mortgage, or five-year ARM, was 4.5% last week, up slightly from 4.41% the week previous. A year ago, ARMs were averaging 2.54%.
Rates for adjustable mortgages are tied to the prime rate. While interest costs start off low, they can surge once the initial fixed-rate period ends.
Some recent borrowers are taking out ARMs in hopes that they’ll be able to refinance into a lower, fixed-rate mortgage by the time the five-year term expires.
How the recent rate swings are affecting the market
Housing activity has undeniably cooled. Close to 12,000 fewer homes sold in April and May compared to the pre-pandemic average, according to the National Association of Realtors.
“It’s a fact that many households are impacted by higher mortgage rates as they no longer earn the qualifying income for the median-priced home,” Evangelou says.
Homebuying, she says, became 15% more expensive in the second quarter — with buyers now needing to earn $104,000 to qualify for a loan on a typical property.
Another change is that more homeowners are listing their properties compared with a year ago at this time. Prices, however, have yet to see any meaningful dips.
In fact, the median price of a home hit a record $450,000 in June, 17% higher than the same month last year, according to Realtor.com.
“At that price, combined with today’s fixed rate for a 30-year loan, homebuyers are looking at monthly mortgage payments of about $2,100 — before adding in taxes, insurance or fees — more than $790 higher than June of 2021,” Ratiu says.
What to read next
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
American Weed Stocks Are Cheap. They’re About to Get a Sales Bump.
How Do Mega Backdoor Roths Work?
A mega backdoor Roth is a unique 401(k) rollover strategy that’s designed for people whose incomes would ordinarily keep them from saving in a Roth Individual Retirement Account. The advantage of using a Roth IRA to save for retirement is being able to make tax-free qualified withdrawals. But not everyone can contribute to these accounts; higher-income earners are excluded. That’s where the mega backdoor Roth comes into play. If you have a 401(k) you’d like to roll over, you could use this strategy to enjoy the tax benefits of a Roth IRA without having income be an obstacle.
Make sure you’re taking advantage of every opportunity to maximize your retirement assets by working with a financial advisor.
Roth Account Basics
Before diving into the specifics of a mega backdoor Roth, there are a few things to know about Roth accounts, including Roth IRAs and Roth 401(k)s.
First, these accounts are both funded with after-tax dollars. That means when you make qualified withdrawals later, you won’t pay income tax on the money since you already paid it upfront. This is the key characteristic of Roth accounts and what makes them so appealing to investors who anticipate being in a higher tax bracket at retirement.
Next, your ability to contribute to a Roth 401(k) is not restricted by your income. But it is for a Roth IRA. For the 2021 tax year, you must be within these modified adjusted gross income limits to make a full Roth IRA contribution:
Single filers: MAGI of $125,000 or less
Married filing jointly: MAGI of $198,000 or less
Head of household: MAGI of $125,000 or less
You can make partial contributions above those income limits. But your ability to contribute phases out completely once your MAGI hits $140,000 (if you file single or head of household) or $208,000 if you’re married and file a joint return. For 2021, the full contribution allowed is $6,000 with a $1,000 catch-up contribution for savers aged 50 and older.
Finally, Roth 401(k) accounts are subject to required minimum distribution rules just like traditional 401(k) accounts. This rule requires you to begin taking money from your 401(k) starting at age 72. A Roth IRA, on the other hand, is not subject to RMD rules.
What Is a Backdoor Roth?
A backdoor Roth offers a work-around for people whose incomes are above the limits set by the IRS. When you execute a backdoor Roth, you roll money over from a traditional IRA to a Roth account. This way, you won’t have to pay taxes on your retirement savings in the Roth IRA when it’s time to make withdrawals. And you’re not subject to required minimum distribution rules either.
But there is a catch. You have to pay income tax on the money you roll over to a Roth account. So while you could save money on taxes in retirement, you’re not escaping the tax liability of a traditional IRA altogether.
How a Mega Backdoor Roth Works
A mega backdoor Roth is a backdoor Roth that’s designed specifically for people who have a 401(k) plan at work. This type of backdoor Roth allows you to contribute up to $38,500 to a Roth IRA or a Roth 401(k) in 2021. This is in addition to the regular annual contribution limits the IRS allows for these types of accounts. To execute a mega backdoor Roth, two conditions have to be met. Your 401(k) plan needs to allow the following:
You can ask your plan administrator whether your 401(k) meets these criteria. And if your plan doesn’t allow for in-service withdrawals or distributions, you could still attempt a mega backdoor Roth if you plan to leave your job in the near future.
If your plan meets the criteria, then you can take the next steps to execute a mega backdoor Roth. This is typically a two-step process that involves maxing out after-tax 401(k) contributions, then withdrawing the after-tax portion of your account to a Roth IRA.
Again, whether you can follow through on the second step depends on whether your plan allows in-service withdrawals. If it doesn’t, you’ll have to wait until you separate from your employer to roll over any after-tax money in your 401(k) into a Roth IRA.
You also need to watch out for the pro rata rule. This IRS rule says you can’t only withdraw pre- or post-tax contributions from a traditional 401(k). So if you’re completing a mega backdoor Roth, you couldn’t just withdraw post-tax contributions if your account holds both pre- and post-tax funds. In that case, you may have to roll over the entire balance to a Roth IRA.
Benefits of a Mega Backdoor Roth
There are three key benefits associated with executing a mega backdoor Roth. First, you can contribute significantly more to a Roth IRA upfront this way. For 2021, the contribution limit is $38,500 on top of the regular annual contribution limit and any catch-up contribution limits that may apply.
You’ll need to know the maximum amount you’re allowed to contribute to the after-tax portion of your 401(k). So for 2021, the IRS allows a maximum contribution of $58,000 or $64,500 if you’re 50 or older. You’d subtract your 401(k) contributions and anything your employer adds in matching contributions to figure out how much you could add to the after-tax portion.
Next, you can enjoy tax-free withdrawals in retirement. This is a benefit you may otherwise not being able to get if your income is too high to contribute to a Roth IRA. By reducing your tax liability in retirement, you can help your investment dollars go further. And you may have a larger legacy of wealth to pass on to future generations.
Finally, a mega backdoor Roth IRA would allow you to sidestep required minimum distribution rules. This means that you could retain control over when you choose to take distributions from a Roth IRA.
So who is a mega backdoor Roth right for? You may consider this move if you:
Have an eligible 401(k) plan at work
Have maxed out traditional 401(k) contributions
Are not eligible to contribute to a Roth IRA because of your income
Have additional money that you want to invest for retirement
Want to leverage the higher Roth IRA contribution limits allowed by a mega backdoor rollover
Talking to your financial advisor can help you decide if a mega backdoor Roth makes sense. And your 401(k) plan administrator should be able to tell you if it’s possible, based on your plan’s guidelines.
Mega Backdoor Roth Alternatives
If you can’t execute a mega backdoor Roth because your plan doesn’t allow it, there are other ways to increase your retirement savings. For example, you could try a regular backdoor Roth instead. This might be something to consider if you still want to enjoy the tax benefits of a Roth IRA but your plan doesn’t fit the criteria for a mega rollover. You could also elect to make Roth 401(k) contributions to your retirement plan at work. This way, you still get the benefit of contributing after-tax dollars and making tax-free withdrawals. You’d be subject to the regular contribution limits and you’d still have to take the required minimum distribution. But that may outweigh the value of tax savings in retirement.
Investing in a Health Savings Account (HSA) is another option. While these accounts are not specifically designed for retirement, they can yield multiple tax benefits. Contributions are tax-deductible and grow tax-deferred. Withdrawals are tax-free when used for eligible healthcare expenses. And at 65, you can take money out of an HSA for any reason without a tax penalty. You’ll just owe ordinary income tax on any withdrawals that are not used for healthcare expenses.
Finally, you could open a taxable brokerage account to invest. This doesn’t necessarily save you money on taxes since you’ll owe capital gains tax when you sell investments at a profit. But it could help you to diversify your investments and there are no limits on how much you can invest in a brokerage account annually.
A mega backdoor Roth strategy could work well for higher-income earners who want to take advantage of Roth account benefits. There are certain rules that need to be followed to make it work, however, so you may want to talk to your plan administrator or a tax professional before going ahead. Keep in mind also that even if you can’t complete a mega backdoor Roth rollover, you still have other options for growing retirement savings.
Tips for Retirement Planning
If you’re saving for retirement in a 401(k) or IRA, pay attention to the fees you’re paying. For instance, check the expense ratios for each fund you’re invested in to understand how much you pay to own that fund on an annual basis. You can then compare that to the fund’s performance to determine whether the fees are justified. Also, consider any administrative fees you might be paying and how those affect your net returns.
Consider talking to your financial advisor about a mega backdoor Roth and whether it could be right for you. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy to connect with professional advisors in your local area. You can get your personalized recommendations in minutes just by answering a few simple questions. If you’re ready, get started now.
Photo credit: ©iStock.com/designer491
Alibaba Is Tumbling. Chinese Tech Stocks Have a New Headache.
Chinese tech stocks were tumbling on Monday as two of the embattled sector’s leading players faced fresh fines from market regulators over disclosure rules.
China’s State Administration for Market Regulation announced Sunday a wave of penalties for improperly reporting past deals, in breach of competition law.
(ticker: BABA) and
(0700.H.K.) were among the companies fined as a result.
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