401(k) vs. Roth IRA, prepaying an underwater mortgage, and other reader questions
401(k) investment makes sense if your employer matches your contribution, but what if they don't (question 9)? Should you prepay an underwater mortgage (question 1)?
What’s inside? Here are the questions answered in today’s reader mailbag, boiled down to five word summaries. Click on the number to jump straight down to the question.
1. Extra mortgage while underwater
2. Homemade pet food
3. How does a mortgage work?
4. Thoughts on franchising
5. The future of Berkshire Hathaway
6. Writing about an employer
7. Switching careers and emergency savings
8. Parents and debt
9. Roth IRA and education savings
10. Career grinding
The Simple Dollar is a blog for those of us who need both cents and sense: people fighting debt and bad spending habits while building a financially secure future and still affording a latte or two. Our busy lives are crazy enough without having to compare five hundred mutual funds – we just want simple ways to manage our finances and save a little money.
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Recently, several readers have written to me suggesting minor format changes to the mailbag.
Starting with this issue, I pretty much incorporated all of them.
I think this will make the mailbag a bit easier to read.
Unless you are planning on walking away from the mortgage and the house, it makes just as much sense to pay ahead on an underwater mortgage as it does on an above-water mortgage.
In either case, you owe a certain amount of money to a lender. Each day (that’s how it’s often calculated), you’re charged some small amount of interest on that loan. So, if you have a 5% loan, each day you’re charged (5/365)% interest in your remaining balance – about 0.014%. If you have a $200,000 balance, that’s $27.40 a day, which adds up to $821.92 over a month. If you make an extra payment of, say, $5,000, you drop the daily interest down to $26.71 and the monthly amount down to $801.37. How does that help you? Your next house payment (and every one thereafter) will have $20 more go towards the balance of your home and $20 less go into the bank’s pocket in the form of interest. You’ll pay off the house quicker because eventually that extra $20 a month will add up to eliminating payments at the end of your mortgage.
Now, why would it not be a good choice to pay ahead? There’s always a small amount of risk when you pay extra on collateralized debt without paying it off, whether you’re paying ahead or not. You weren’t required to pay that money, and if things fall apart later on and the house is foreclosed upon, you’ve simply lost those extra payments. Of course, this is only a significant concern if you’re in a house where you’re struggling to make the basic payments – if you’re financially secure enough to handle the payments and an extra monthly payment, then this isn’t much of a risk.
I consider that risk small enough for almost everyone that the financial gains of paying ahead blow it out of the water. So, unless you’re going to walk away, I’d pay ahead when I could (unless you have other debt that has a higher interest rate, of course).