MSAs, IRAs And Interest Only Mortgages

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 The biggest drawback to this kind of savings is the penalty you pay if the money is not withdrawn for its intended purpose, paying for medical expense.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 The IRA account is supposed to be used by the consumer as a tool for retirement savings; if the money must be withdrawn prior to reaching a certain age, there is often a 10% penalty to be paid on early withdrawal.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.