MSAs, IRAs, and Interest Only Mortgages
Interest only products and the mortgage market don't seem like
they would have anything to do with an MSA, SEP or an IRA; but
they can, and sometimes it's to your advantage if they do.
First, let's explain what an MRA and IRA are, and how you can
use them to your benefit. While offering the explanation, we'll
look at how they can be used in conjunction with interest only
mortgages as a benefit to the consumer.
An MSA, or medical savings account is a tax-deferred way to save
money, especially if you are self-employed, and do not have a
401k or medical insurance. The medical savings account gives you
a tool for taking a deduction straight off your bottom line,
thereby reducing the amount of tax you owe. The mortgage
interest portion of your mortgage only provides a tax deduction
in the form of an itemized deduction, and it is limited to a
certain percentage of your income. Refinancing, or first-time
financing of your mortgage with an interest only mortgage, can
be used to pull more of the equity out of your home, or save
money on mortgage payments that can be used to fund an MSA
account. The biggest drawback to this kind of savings is the
penalty you pay if the money is not withdrawn for its intended
purpose, paying for medical expense. If you find yourself in a
situation where you must have the money, and it's not for
medical expenses, you can pay up to 10% in penalties.
The IRA or individual retirement account works on the same
premise as an MSA. The IRA is intended to give the consumer a
way to save for retirement, when there is not a retirement plan
where they work or they're self employed. The interest only
mortgage can be used in the same way as was explained above, and
with the same restrictions. The IRA account is supposed to be
used by the consumer as a tool for retirement savings; if the
money must be withdrawn prior to reaching a certain age, there
is often a 10% penalty to be paid on early withdrawal.
The SEP is the equivalent of the 401(k) for the self-employed
individual. How does the SEP work? Basically, you as a
self-employed individual can allocate up to $20k each year to be
put into an SEP, or self-employed pension. The money is treated
as tax deferred income, and it comes directly off your AGI, just
as if you participated in a 401(k).
As you can see, the MSA, IRA, or SEP offer the consumer direct
one-to-one savings by reducing their AGI, or the amount of
income for which they are going to incur a tax liability. The
mortgage interest portion of their itemized deductions is not a
dollar for dollar reduction; it is limited to a percentage of
your AGI. But what if you could find a way to benefit from both
deductions? Would that not create a more beneficial tax and
savings situation for the homeowner? Quite possibly, and the
only way to assess your real savings is to sit down with a
financial analyst and look at your individual situation.
The only way to really benefit from this possible scenario,
however, is to make sure that you have ample savings from the
interest only mortgage payment versus the traditional payment,
to justify making such a move, and that the money will actually
make it to a tax-deferred savings account.
What is the potential savings for the consumer? Well, imagine
the following situation: self-employed taxpayer wants to buy a
home. He has $10,000 available in cash to either put down on the
house, or put into an SEP; his tax liability without the SEP
will be $8,000. With the $10,000 SEP, he would receive a refund
of $600.00. He can only afford to make mortgage payments of
$600; the house he's chosen financed with a fixed rate mortgage
would be $826 each month. Using the interest only mortgage
option, his monthly payment for the next 5 years is only $488
and the mortgage product does not require a down payment. It
frees up the $10k to be put into the SEP and the taxpayer
benefit will also include deductible mortgage interest. As you
can see, with this illustration, financial planning and fully
utilizing your options can make a tremendous amount of
difference in your life.