Go on take the money and run?

August 18, 2008 6:51 PM

Use the new Federal Housing Tax Credit as an investment seed?

Is there anything fundamentally wrong with this idea?:

Take the new Federal Housing Tax Credit and dump the $7500 into a Roth IRA. Repay the 'credit' at the normal rate (~$500/year for ~15 years I think).

This seems like a no brainer to me, but I am not very financially savvy. Its essentially a no-interest loan, so it I would think that investing no-interest money is a win-win, but then again, I'm dense enough that I once thought I had a system to beat a casino's video roulette machine. (long story short, I emphatically did not)

Thoughts? Is there a better way to optimize the 'credit'? Is it best to leave it alone?

Bonus points for finance/investment gurus: Assuming moderate gains (8%???), how much ahead am I by being able to invest the $7500 up front, versus the alternate scenario of investing $500/year for 15 years.

posted by ian1977 to work & money (13 comments total)

Oops...pertinent info...already bought the house, within the timelines given for the credit.
posted by ian1977 at 6:54 PM on August 18, 2008

It seems mathematically sound.
posted by gjc at 6:59 PM on August 18, 2008

The only caveats here are that you can't put all $7500 in to the IRA at once due to contribution limits (so you'll need to stash about half of it somewhere else until the next calendar year rolls around), and obviously you'd be paying back the $500 / year out of pocket rather than out of the IRA. But it sounds like a good plan.

How much better is $7500 up front rather than $500 / year over the same period? A lot. This is a good sort of problem to hone your spreadsheet skills on. Go forth and multiply, sir.
posted by 0xFCAF at 7:04 PM on August 18, 2008

Well, according to this calculator, you get $24800 from investing 7500 at 8%, and you lose $14400 (because you're paying it back, and you lose the interest on what you've paid back also). So you end up with $10400 (minus taxes), which is not bad at all.
posted by alexei at 7:07 PM on August 18, 2008

I'm not sure I see the logic of how he loses $14400. It's a no interest loan. He is spending $7500 (500 a year) to get $24800. Seems like a net of $17300, to me.
posted by gjc at 7:16 PM on August 18, 2008

gjc - I think its factoring in the opportunity loss of not investing that $500/year.
posted by ian1977 at 7:24 PM on August 18, 2008

It's mathematically sound if the rate of return is as high as you assume.

The S&P closed at 1083.67 on Aug 17 1998. It closed at 1278.60 on Aug 18 2008. That's less than 2% a year over the last 10 years, or less than inflation. Does that mean the next 10 years will be the same? Obviously not. I sure hope it isn't. But there ain't no such thing as a free lunch and if the market craters or something, well, you're out of pocket.
posted by Justinian at 7:54 PM on August 18, 2008 [1 favorite]

Uh, I didn't include this but it goes without saying; you also have to buy a house which means you're paying a mortgage or whatever that you didn't have before. I'm not sure it makes sense to pay $3000 a month in mortgage payments to "make" $7500. If you're going to buy a house anyway, of course, that's a different story.
posted by Justinian at 7:58 PM on August 18, 2008

Justinian, he already bought the house.
posted by atrazine at 10:48 PM on August 18, 2008

gjc - I think its factoring in the opportunity loss of not investing that $500/year.

That's what I figured he was going for. Except that's not part of the equation/question.

Choices in this scenario are:

1- Do nothing. Keep $500 a year.
2- Invest $500 a year.

Sub choices of 2 are:

2a- Invest $500 a year. Earn interest as that compounds.
2b- Invest $500 a year. Borrow $7500 interest free to seed the account. Earn more interest.

I don't see any opportunity loss. The only difference between 2a and 2b is who you are giving that $500 a year to.

Maybe I just misunderstood his language choices. His calculations show the difference between 2a and 2b, but calling the $14400 a loss confused me.
posted by gjc at 7:59 AM on August 19, 2008

Isnt it only a credit on your income taxes? So its not a definite 7500 right?
posted by majortom1981 at 8:44 AM on August 19, 2008

gjc - it is an opportunity loss in a classical economics sense. If I do X then I can't do Y. So the opportunity loss of doing X is not being able to do Y.

In this case the opportunity loss of investing the $7500 outright (and paying it back $500/year) is not being able to invest the $500/year. The end result of investing the $500/year is $14400. The end result of investing the $7500 outright is $24800. The net gain from opting to invest the $7500 outright is $10400 (24800-14400).

So while there is an opportunity loss of opting not to invest the $500/year, I would still be ahead $10,400 by choosing to invest the $7500 outright.

By the same token, if I chose to invest the $500/year, there would be an opportunity loss of NOT being able to invest the $7500 outright. In that scenario the opportunity loss would actually outweigh the end result of investing the $500/year.

of course that all assumes 8% interest.
posted by ian1977 at 9:37 AM on August 19, 2008

Presumably whatever investment you have in mind that will give 8% interest has some amount of risk.

You can pay off some of the principle of your loan without that risk. Do you have a second mortgage with a high interest rate on the house, or are you paying PMI? You might want to take care of these, either instead of the roth or with the funds in excess of the roth contribution limits.
posted by yohko at 12:57 PM on August 19, 2008