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I am considering whether to start expanding my investments, but I am looking at all of my other debts before I move that route. One such decision is the choice concerning whether or not to start an investment fund in addition to my 401K. (Most likely a Roth IRA, because my wife and I still come in under the required MFJ income, but just barely)
Just some bullet points:
-I am 30, my wife is 26.
-Our combined income is in the mid $100K range
-Currently I contribute 12% to my 401K. (Employer provides a 3.5% match)
-I'm considering backing off of the 401K contribution a bit and putting the extra into a Roth IRA while we still fall under the income guidelines.
-We have a satisfactory emergency fund in Savings
-Only long term debt is the mortgage (Student loans paid off, cars are paid off, and I'm paying for my MBA with my quarterly bonus checks. I've budgeted everything on my base salary.)
So my question is this - since we bought the house 13 months ago, with a 5% down payment, we pay $95 per month in PMI. My mortgage company says once we have owned the house for 2 years, we can get rid of PMI if our equity is at least 25% based on a new appraisal. With home values the way they are, I feel we can come close to reaching this goal by month 24.
Would it be financially advantageous to put all extra money towards our principal over the next year instead of opening the Roth IRA at this point? I know the Roth has a maximum contribution of $5,500 per year. The $95 PMI adds up to about 20% of that over the year. So if I'm thinking about this correctly, if I decided to invest and not try to build up to get rid of the PMI, I'd theoretically be taking a 20% loss each year that I could have gotten rid of the PMI, but didn't.
Is this a reasonable line of thinking? Any feedback is apprecatied!!
You are most likely looking at it the wrong way. Given the information you provided, here are your two scenarios at month 24:
Scenario 1: No Roth IRA, 25% equity in home
Scenario 2: $5,500 in Roth IRA plus any appreciation/depreciation, $5,500 away from having 25% equity in home
In Scenario 2, the amount you lose in PMI payments that you would not lose in Scenario 1 is equal to the months it takes you to save $5,500 multiplied by $95. So if it takes 5 months for you to save $5,500, you lost $95*5=$475 from PMI payments that you would not lose in Scenario 1. In Scenario 2, once you save $5,500 after month 24, you can get to that 25% equity mark and avoid PMI. Therefore, the amount you lose in Scenario 2 is strictly a function of how quickly you can save $5,500 after month 24. The amount you lose in Scenario 1 is equal to the present value of the total return of the $5,500 contribution that you did not make less interest savings from your mortgage.
Without more details, I cannot make a definitive call on which scenario is better. However, Scenario 2 is most likely the better option given the massive amounts of compounded return you would be giving up in Scenario 1.
You are most likely looking at it the wrong way. Given the information you provided, here are your two scenarios at month 24:
Scenario 1: No Roth IRA, 25% equity in home
Scenario 2: $5,500 in Roth IRA plus any appreciation/depreciation, $5,500 away from having 25% equity in home
In Scenario 2, the amount you lose in PMI payments that you would not lose in Scenario 1 is equal to the months it takes you to save $5,500 multiplied by $95. So if it takes 5 months for you to save $5,500, you lost $95*5=$475 from PMI payments that you would not lose in Scenario 1. In Scenario 2, once you save $5,500 after month 24, you can get to that 25% equity mark and avoid PMI. Therefore, the amount you lose in Scenario 2 is strictly a function of how quickly you can save $5,500 after month 24. The amount you lose in Scenario 1 is equal to the present value of the total return of the $5,500 contribution that you did not make less interest savings from your mortgage.
Without more details, I cannot make a definitive call on which scenario is better. However, Scenario 2 is most likely the better option given the massive amounts of compounded return you would be giving up in Scenario 1.
Thanks for the feedback. I realize now I didn't give all of the financial specifics.
The $5,500 number was just the max for the Roth IRA. I am actually $20,000 away from paying down the principal enough on my home over next year to get rid of PMI. So here are my options. I probably have enough extra "investment" income over the next 12 months to invest (or pay down principal) $20K. I am still contributing to my 401K and maxing the employer match during this time, btw.
Here are my scenarios:
1) Pay down $20K extra on my principal over the next year, and eliminate the PMI moving forward. (This saves $1,100 per year moving forward after the end of year 1 but no extra investment beyond my 401K to meet my employer match. The return is the elimination of $1,100 a year in PMI)
2) Contribute to Roth IRA at $5,500 per year, (maximum annual contribution), and contribute all extra to principal. This would mean $14,500 would go towards the principal year 1, and I'd end up paying down the principal enough to pay off the PMI 6-8 months later than with scenario 1. ($570 - $760 more in PMI)
3) Contribute to Roth IRA at $5,500 per year and the extra $14,500 into some other type of other investment account. Keep paying minimum mortgage payments, and it takes me 5-8 years to get rid of the PMI. This would cost me $5,500 to $8,800 in PMI over this time, so my investments would have to return at least that much make this the right option.
There are no income limits to Roth IRAs when back doored. What there are is a restriction as to how much and it's quite small. Stuff everything you can into the IRA, pay off PMI, put $18k into your 401k, then add to brokerage is the way I would do it.
Also provided she has $5500 in income contribute to one in her name as well.
Thanks for the feedback. I realize now I didn't give all of the financial specifics.
The $5,500 number was just the max for the Roth IRA. I am actually $20,000 away from paying down the principal enough on my home over next year to get rid of PMI. So here are my options. I probably have enough extra "investment" income over the next 12 months to invest (or pay down principal) $20K. I am still contributing to my 401K and maxing the employer match during this time, btw.
Here are my scenarios:
1) Pay down $20K extra on my principal over the next year, and eliminate the PMI moving forward. (This saves $1,100 per year moving forward after the end of year 1 but no extra investment beyond my 401K to meet my employer match. The return is the elimination of $1,100 a year in PMI)
2) Contribute to Roth IRA at $5,500 per year, (maximum annual contribution), and contribute all extra to principal. This would mean $14,500 would go towards the principal year 1, and I'd end up paying down the principal enough to pay off the PMI 6-8 months later than with scenario 1. ($570 - $760 more in PMI)
3) Contribute to Roth IRA at $5,500 per year and the extra $14,500 into some other type of other investment account. Keep paying minimum mortgage payments, and it takes me 5-8 years to get rid of the PMI. This would cost me $5,500 to $8,800 in PMI over this time, so my investments would have to return at least that much make this the right option.
I would go with your Scenario 2. Even though you will be paying a few hundred more in PMI, you are likely to make up for it and then some with the extra Roth IRA contribution. Remember, if you do not make the Roth IRA contribution this year, there is no way to make up for it in the future.
Invest in Roth. Even at a modest 4% growth, the gains from IRA will surpass PMI payments within 5 years.
He would also save on the interest from the reduced mortgage balance, so he could be better off getting rid of the PMI.
For me, I would get rid of the PMI. It is a guaranteed return (between the eliminated cost and saved interest), and reduces monthly expenses, which increases monthly cash flow.
Given the OP's income, I am wondering if some costs can be reduced from the monthly budget that can help to speed up the process.
He would also save on the interest from the reduced mortgage balance, so he could be better off getting rid of the PMI.
For me, I would get rid of the PMI. It is a guaranteed return (between the eliminated cost and saved interest), and reduces monthly expenses, which increases monthly cash flow.
Given the OP's income, I am wondering if some costs can be reduced from the monthly budget that can help to speed up the process.
Very good point on the interest. So my 20k investment year 1 would give me a $1,100 return in PMI plus interest savings of 750. (20k off principal at 3.75% rate) So that is a 9.25% guaranteed return on my $20k. I'm leaning towards making that my priority and then any potential extra into a Roth. I'd have to sit down and do a deeper dive into what's possible if I back off my 401k comtribution to cover the employer match and nothing more for a bit.
As for speeding up the process, my mortgage company states that no matter what I must have owned the house for 2 years, so I've got to wait another year regardless on that piece.
Sounds like the OP is doing quite well at a young age.
My suggestion to anyone who wants to minimize debt is refi to a 15 year mortgage. Now it isn't sexy as buying some hot XYZ stock, but its REAL savings.
Of course, someone will come in here and wax poetically about how you can make more money in this or that market......but they can't guarantee ANYTHING. OTOH, I can GUARANTEE you wil save tens of thousands of dollars.....its real money.
In our case, the savings exceed $150,000.00.....so its enough for a nice used Ferrari, better for me to have it than the banker
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