‘I am a 53-year-old single man with very little savings’: I want to take out a 30-year mortgage, but pay it off in 7 years. Is that possible?
I am a 53-year-old single man with very little in savings. I paid off all my credit-card debt a couple of years ago. I have now decided to purchase a home. My rent has increased to the point where it is almost as much as a mortgage, and that is why I am purchasing a home. I am trying to pay off the mortgage as quickly as possible.
My credit-union credit card allows me to make a balance transfer at 0% financing with no fee once a year. It is a very high credit limit, and I was thinking of taking that and putting it on the mortgage as a way of paying off the mortgage sooner, rather than making extra payments every month to the mortgage company.
If I do it this way, I can pay off the card during the year, and save a lot of interest on the mortgage. My calculations for paying a weekly principal payment means the house could be paid off in less than seven years. I believe it would be a little better with making a large up-front payment. Just wanted to know your thoughts on this matter.
Here are my figures: a $260,000 mortgage over 30 years with monthly payments of $1,390 a month. If I pay an extra $2,500 a month, I can pay it off in about seven years. But paying $25,000 once a year may be a little faster.
Would-be Home Buyer
Dear Would-be Home Buyer,
First, let’s talk about your plan in principle: By taking out a 0% loan on your credit-union credit card for your downpayment, you are robbing Peter to pay Paul. But in this case, you are both Peter and Paul. I’m sorry to get all Dostoevsky on you, but you need to tread carefully, as you risk committing yourself to both a mortgage and a loan. If you fall behind on the latter, you will likely face hefty repayments when that 0% interest ends.
In practice, your bank in all likelihood (I can say with 99.999% certainty) won’t accept a credit-card payment as a down payment. Your financial institution wants to know that your credit and bank account is healthy. The down payment is a vote of confidence in that, and should come from your savings rather than your credit card. When you apply for a loan, the bank will also conduct a forensic examination of your finances before agreeing to a mortgage.
I’m not the only one to sound warning bells. “Dangerous Curves Ahead!” says David Waltzer, a New York-based bankruptcy lawyer. “What happens when you are late with just one payment, and that zero-interest rate jumps up to 18%? What happens when you have another rough period and can’t pay off the card on time? Even if you make all the payments perfectly on time, these credit-card companies do a regular review of your credit.”
Credit-card companies also have a lot of small print. “You plan to transfer a low-balance debt to another low-balance card. But what happens when that new low-interest offer never arrives? Now you are unable to make credit-card payments — and you will struggle with the mortgage as well,” Waltzer adds. “I have filed tens of thousands of bankruptcies in New York and New Jersey. Many of them were for people who tried to do what you are describing.”
David B. Rosenstrock, founder and director of Wharton Wealth Planning in New York, warns about the impact on your credit score. “According to myFICO.com, 30% of your FICO
score is based on data that includes your utilization ratio,” he said. “Credit-utilization rate means the amount of your available credit that you are using at the time your score is calculated. You want to keep this utilization under 10% if your goal is to keep your score well into the 700s.”
What’s more, investing in a down market can also pay dividends, assuming you have time for shares to recover, and have the tolerance to withstand further falls. “A 30-year mortgage gives you 30 years to outperform your mortgage rate,” Rosenstrock said. “In general, you shouldn’t neglect retirement account contributions to pay off your mortgage on an advanced timeline. It is also important to always maintain an emergency reserve. Paying down your mortgage too fast at the expense of your emergency savings reserve can create problems if unanticipated events occur.”
“‘You are robbing Peter to pay Paul. But in this case, you are both Peter and Paul. I’m sorry to get all Dostoevsky on you, but you need to tread carefully.’”
Your base monthly repayments look slightly optimistic. Talk to a financial adviser about your goals, and your reason for becoming a homeowner. The big missing piece here is your salary and, to a lesser extent, the prospect of an inheritance. Please seek the advice of an adviser before jumping in. Lay your finances, your hopes and your dreams bare, especially where you would like to be when you reach retirement age, and whether you see yourself working beyond the traditional retirement age.
I fully support your wish to buy a home. Let’s say you work for another 15 to 20 years: You will not only have gained that equity in your home with your monthly mortgage payments, but your home will also presumably — or very likely — have risen in value over that time, giving you more options should you wish to cash out and move to a smaller home. With inflation and, hopefully, a higher salary, you may also find that your mortgage payments become manageable.
You’re 53. You don’t have to pay this loan off in seven years, and you don’t need to rack up extra debt. If your mortgage servicer allows it, paying off a regular amount on your mortgage — given that you are simultaneously paying off interest — can be more effective than an annual lump sum. For those who can afford to pay extra, both are a good idea as long as you ensure you have necessities such as an emergency fund.
“If the goal is to pay down the mortgage faster, ask your mortgage lender if you’re able to make additional principal-only payments and if there are any pre-payment penalties,” says Jennifer Weber, vice-president, financial planning at Weber Asset Management. “A principal-only payment would help save on interest and allow you to pay off your mortgage early. If allowed, you can increase your monthly payments or make larger annual lump-sum payments directly to the mortgage company.”
Waltzer is more circumspect on the benefits of home ownership than I am. He warns that your mortgage interest rate could also exceed 5% if you have a low credit score. “Home ownership costs are always more than expected,” he adds. “If you are purchasing a $260,000 house, I presume you will put 10% down ($26,000). But closing costs will be quite a bit more. So, you are probably looking closer to $40,000. Is that going to be wrapped into your mortgage?”
Greg McBride, chief financial analyst at Bankrate.com, adds, “Owning a home carries a lot of expenses beyond the regular monthly mortgage payment and it is those irregular, unplanned, and sometimes significant expenses that can undermine financial progress. The best antidote to that — and especially for someone who has had credit-card debt in the past — is to build up an emergency savings cushion. Without adequate emergency savings, even the best laid plans are one unplanned expense from failure.”
Lay out all of your options: 15 years vs. 30 years; the pros and cons of paying extra versus saving that money; insurance and property taxes; house repairs; closing costs; and potential bidding wars. The shorter the term — a 15-year mortgage rather than a 30-year mortgage — the lower the interest payment. Still, rates are rising: Monthly mortgage payments with a 30-year mortgage rate and a 20% down payment are roughly 50% more expensive than they were a year ago.
And, finally, the Moneyist is an optimist (most of the time): You may not be single forever.
Check out the Moneyist private Facebook group, where we look for answers to life’s thorniest money issues. Readers write in to me with all sorts of dilemmas. Post your questions, tell me what you want to know more about, or weigh in on the latest Moneyist columns.
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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
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