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)?

Illustration / Clay Bennett / The Christian Science Monitor / File
Worried that your 'golden years' may only be gold-plated? Figuring out how to invest for your future is tricky, especially if you're not sure whether to invest in a 401(k), a Roth IRA, a traditional IRA, or an ordinary investment account.

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

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.

Q1: Extra mortgage while underwater
Is it worth it to pay extra on your mortgage when you are considerably underwater in your house?
- Leslie

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).

Q2: Homemade pet food
Have you ever made your own cat food or done research on whether pets can thrive on homemade food and whether it’s actually cheaper?
- Delores

The problem with feeding your pet homemade foods is that you don’t have clear signals to determine if you’re feeding your pet foods that will contribute to their long-term health or not. The dietary needs of both dogs and cats are different from humans and different from each other as well. Each finds different things to be toxic, different things to be healthy, and different things to be unhealthy.

I compare feeding pets to feeding my children. I have thirty years of knowing what a human diet is like and can use that as a guideline for feeding my own children a balanced diet – plenty of fruits and vegetables, some protein, etc. I do not have that kind of experience with a cat or dog diet, nor does anyone outside of a veterinary research clinic. Beyond that, I can gain additional feedback from my children through conversation – at best, I can rely only on the responses from my pet, which may be caused by the food – or an unrelated ailment, or a particular ingredient, and so on.

In short, I don’t think I’m trustworthy for making pet food. There are too many variables and too little feedback on those variables to make sure that I’m giving my pet a healthy diet. Even if it were less expensive, I wouldn’t trust it.

Here’s a simple example: cats need some amount of taurine in their diet because their pancreas cannot synthesize it. If they don’t get taurine, they go blind at a very early age. If you feed your cat a homemade diet rich enough in taurine to meet their needs, you run other risks due to an imbalanced diet.

If I had a pet, I’d probably ask my vet for a recommendation and follow that recommendation.

Q3: How does a mortgage work?
I want to buy a house. I just got my credit report in the mail through my bank, and my scores are pretty bad, but salvageable. I have almost no real “debt” so to speak – I have one personal loan that I owe about $700 on, and the rest is all defaulted bills and such, totaling just under $4,000. Not too shabby, in the grand scheme of things, I think.

My husband and I both worked happily in a hiring-hall union, which meant that we only worked a few times a month but that the hourly wage was so high that it paid all of our bills – just barely. I am tired of this and have taken a relatively low-paying job that is full-time and reliable, and will pay all of our bills on it’s own (we live rather cheaply). This way the money my husband brings in can go toward fixing my credit (his is at the moment beyond our scope of repair, as he had several years longer than I to screw it up). I’m not entirely thrilled with the job – it’s not intellectually stimulating in the least and I’m on my feet for a good chunk of time – but to me it’s worth it to get the debts paid off and start saving up for a down payment and a general emergency fund.

I think that within a year I can get my debts all paid off and have a decent down payment saved up. Right now there are several homes going for very cheaply in my area and it’s my hope that the market will be somewhere near this when I get everything settled. As you can see, I’ve got a plan and I’m plowing through it. My confusion lay with the way mortgages work.

I’ve tried finding information on the internet and it’s done nothing to help clarify. How is the interest applied? How do monthly payments work? Does the bank pay your taxes? I have a friend who was a mortgage broker for a long time and she was totally unable to explain to me how it worked in terms that didn’t just confuse me. I have for the time being termed it “magic math.” I would like to figure out, based on a gross overestimation, what a general monthly mortgage payment would be for my husband and I so I can begin to build that emergency fund with the right numbers in mind. If you could help me:

A 30 year fixed-interest loan at the appallingly horrible rate of 9%, for, say, $60,000. Could you break that down for me in simple terms? I have to say, this “magic math” has got me totally stumped.
- Natasha

The first thing I would suggest that you do is start playing around with a simple mortgage calculator, like the calculator at Bankrate.com. It can easily take the terms you provide ($60,000, 30 year mortgage, 9%) and give you your monthly payment ($482.77) and a chart showing you how much of each payment is going to interest and how much is going towards the balance of your mortgage.

In more general terms, here’s how it works:

When you take out a mortgage from a bank to buy a house, the amount you borrow from the bank is called the principal.

The bank will charge you some interest rate on that principal.

So, in your example, you have a loan with a balance of $60,000 and a 9% interest rate. Over the course of a year, the bank would expect you to pay in (approximately) $5,400 in interest – that’s 9% of $60,000. You do that by converting the percentage to a decimal – 9% becomes 0.09, 4% becomes 0.04 and so on – and multiplying the two numbers together – $60,000 times 0.09 is $5,400.

(Why did I say “approximately”? Banks usually use a more complicated form of this calculation that usually results in a slightly higher amount of interest – it would be somewhere around $5,480 for a year, but that’s not important right now.)

Now, you’ll be making about $5,400 in interest payments over that first year. Just divide that interest by 12 (for the number of months) and you have $450.

So, your first payment would consist of $450 in interest plus some amount from the principal. As we calculated above, the payment would be $482.77, so your principal amount would be $32.77. After that payment, you now owe $59,967.23 on the house ($60,000 minus $32.77).

Now, you essentially do the math all over again, except you have a new loan balance of $59,967.23. $59,967.23 times 0.09 is $5,397.05. Dividing that by 12, you get $449.75. Thus, on your next payment, you would be paying $482.77, of which $449.75 goes to pay the bank the interest you owe them and $33.02 would go towards your principal.

With each payment, a little bit more goes towards the amount you owe and a little less goes towards the interest, until the home is paid off.

I hope that makes things more clear for you.

Q4: Thoughts on franchising
I’ve been a lifelong employee, and I’m considering the idea of buying a franchise. I’m 42 years old and and mostly debt-free (I have an auto lease and I rent an apartment) with a reasonable amount saved.

What are your general thoughts about this versus starting one’s own business?
- Michelle

The biggest drawbacks to becoming a franchisee usually come from how the business is run internally. How controlling is the franchisor? How expensive is the franchise fee? How much support do they offer you as a new franchisee?

Since you actually work for such a franchise, you should be privy to at least some of this information. Are there a lot of “corporate” procedures you have to follow or do you define them all locally? Is the manager and owner in regular contact with the larger company or do you seem to be pretty much on your own?

Since you work there, you probably have a pretty good grasp on these issues, as well as the legitimacy of the business.

You should note, though, that becoming a franchisee for a well-known business is often very expensive and they’re often very picky about allowing people to become franchisees if they don’t have a fat wallet.

Q5: The future of Berkshire Hathaway
Given Warren Buffett’s age, would you suggest buying shares of BRK-B for the long haul?
- Lacey

My belief is that you buy individual stocks for a specific reason and, if that reason no longer exists, you sell the stock. That’s actually pretty standard investment advice.

What’s your reason for buying BRK-B stock? For most people, it’s probably Buffett and Munger as a team – I know that would be my reason. I would be buying, in essence, to invest in those two guys. If one (or both) of them went away, my reason for investing would be gone, so I would sell.

All I can tell you to do in this case is understand why you would buy BRK-B and whether that reason is changing or not.

Q6: Writing about an employer
I work at a company which is headquartered in another company. The foreign management conducts business differently than an American company would in many ways. Unfortunately, that has caused a lot of problems over the years, and has partly let to the potential of the whole company being lost within the next 2 years.

I have heard from many persons that they should ‘include this or that in their book’, with regard to the goings on at this company. My question is: is it possible to safely write a book about experiences from a job without getting sued for slander/libel? I know I could change names and places to make them have no apparent connection, but is that enough legally? My book would likely follow a pattern of introducing a management failure and then explain why that caused turmoil and how it could have been avoided/mitigated.

I’ve never written a book before, but didn’t want to pursue this one if it will cost me millions in fines and net me a prison term! Thanks in advance for any advice you may have!
- Luke

Libel is a false statement of fact about an employee or organization. Opinions are not libelous – false facts are.

Keep that strongly in your mind as you move forward. If you’re going to be stating something as a fact, document it as thoroughly as you can right now. Get evidence of this fact and make sure you’re not extending your “factual” claim any further than you can based on the actual information.

People get into trouble with libel when they make negative claims about a person or organization without facts to back it up – even if they change names.

Here’s an example. If I write I dislike Robert Kiyosaki’s work, that’s an opinion – I’m fine. If I write Robert Kiyosaki has written hateful things about people who earn a living wage, I’d better have a fact to back it up – and I do, by simply pointing to any copy of Rich Dad, Poor Dad and the passage where he calls employees “hamsters.”

Any respectable publisher will help you carefully check such a book for libel. If you’re even considering self-publishing something like this, hire a libel lawyer to help you avoid any pitfalls – it’ll be expensive, but it’ll keep you out of much worse trouble later on.

Q7: Switching careers and emergency savings
I am 27, single with no kids, and a homeowner. About 5 months ago I changed jobs after being with the same company for over 4 years. It was time to move on, but I hate my new employer and my position at my new employer. It is to the point that I hate getting out of bed every morning and the stress and overall distaste for the company is impacting my life and health outside of work. With that said I have a mortgage and other expenses just like other people. I have saved my money well through the years and have an emergency fund of 13 months of living expenses and have no debt outside of the mortgage. Part of me just wants to quit my current job and start looking for a new job full time, but I know that this could take months. The other part of me would hate to tap into my savings that I have worked REALLY hard to develop. What are your thoughts on my situation? What would you do?
- Ted

I’d keep my current job, but recognize it for what it really is – a job. You go there, put in some hours, get some money. It’s not a career builder for you. Don’t let the overarching issues going on there bother you in the least. Just do whatever work is on your desk.

Use that energy (and time) you’re saving to apply for another job. Don’t be too picky about it, particularly in the current job market and your current situation. When you get up in the morning, don’t think about your current job. Think about your next one. That’s where your heart and energy should be.

Your suffering is coming about because you’re putting too much emphasis on your current unpleasant job (a short-term concern) and too little on what’s down the road from there (the long-term concern). Look long and hard at that long term and start taking actions today to get there.

Q8: Parents and debt
My father was venting to me the other day about my mother and her spending habits. She is going to be 55 in November, has a lot of credit card debt (my father did not give me an exact figure, but it is high), and wants to retire at some point in her life. By no means am I a financial expert, and by no means am I in the greatest financial position myself. My wife and I are currently using Consolidated Credit Counseling Services to help ourselves get back on track with our debt. My father also hinted around he may want me to suggest CCCS to her. Do I give my father the information about CCCS and he can forward it to my mother, or should I just do it myself?
- Joe

This is an issue that depends heavily on the relationship dynamics involved. How close are you to your mother? Do you talk to her regularly? Do you talk about most issues in your life or is your relationship more distant? Do you think you are a very valuable influence in her life? More importantly, are you personally concerned about this debt situation or is it more that you’re concerned because your father is?

The deeper your connection to the issue and the deeper your connection to your mother, the more you should consider bringing this issue up yourself with her. If there is more distance, let your father do it.

Why is this important? Sharing such information is likely to trigger a pretty difficult situation that functions best if there is a lot of trust and rapport flowing both ways. If there isn’t, there can easily be a lot of resentment and denial just from sharing the information – something you don’t need to be dealing with if you don’t have a very close relationship.

Q9: Roth IRA and education savings
I am 24, and have been working full-time for two years. I plan to go to law school next fall. I save 7.5% through my work’s 401k (they don’t match), and I currently have ~$13,000 in a Vanguard Mutual Fund, and $10,000 in a Money Market fund. I am considering moving $5,000 of that into a Roth IRA. Does it make sense to do this, even if I will very likely have to take out school loans for law school next year? And if so, where would it make the most sense to pull the money from? I am able to save ~$200/month from my take-home pay, which is currently going to the Mutual Fund.
- Julia

Unless the 401(k) program at work is stellar, I would reduce the 401(k) contributions and use those to open a Roth IRA. The Roth will result in better long-term returns for your money.

If you’d prefer to fully fund the Roth out of what you already have and not touch the 401(k), I’d sell $5,000 of the mutual fund and get it into the Roth.

In either case, I’m not sure I would keep the mutual fund. You’re apparently saving for a goal that’s just a year down the road, and the one year volatility in the stock market can be tremendous. You could be up 10% in a year – or down 30%. You’re better off guaranteeing that you’ll be up 1-2% in that money market instead.

Q10: Career grinding
I am a poker professional who has averaged mid six-figure incomes last 2 years. This year I’ve had problems motivating myself and just simply grinding mindless hours that I used to do with ease.

This year I’ve been sucessful in motivating myself into other challenges relating to fitness and nutrition, but how can I get back on track and start working hard again? I know I will be very angry at my self at an older age if I continue this way.
- Mike

This sounds to me like you’ve lost touch with your passion for poker, the thing that once drove you to play a lot. Something once made you love it and that something is gone now.

What was it that first made you fall in love with the game? Was it watching the World Series of Poker on ESPN? Was it playing with friends? Was it those first early online wins? Was it the mathematical challenges?

If I were you, I’d return to those things that made it fun in the beginning for a while. Watch the “dumb hands” they show on television and just be entertained. Play with some friends for nickels. Learn a completely different type of poker, like Omaha, or even a completely different game for a while.

Or just take a complete break from the game for a couple months. Take the rest of the year off from poker and catch up on other things in your life. Then start from the point where you can fall in love with the game again.

Got any questions? Email them to me or leave them in the comments and I’ll attempt to answer them in a future mailbag. However, I do receive hundreds of questions per week, so I may not necessarily be able to answer yours.

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