Understanding FICO® Scoring

[sleddog]

Here's my idea. Tell me if there is anything wrong with my logic.

I cash out an IRA. Pay off my credit card balances (which are very high) and put the rest of the money in a money market account.

Wait until the zero balances increase my FICO score (30-45 days).

Refinance my mortgage at good terms made possible by the higher score.

Use the cash out from the mortgage to repay the "loan" and put the money into another IRA in time to beat the 60 day deadline for rollovers, thereby avoiding taxes and penalties.

I have a lot of equity and my low FICO score is the only thing keeping me from getting decent terms. Seems to me that this will raise it enough to make a significant difference.

[mattwarner]

It may take 30-45 days to see any change on your scores - is it just the utilization that's keeping them down?  Also, can you be certain that your new mortgage will close within the window of time you need to cash out and reinvest?  If anything's slow at all, you should be ready to get hit with the tax consequences for withdrawing your IRA.  Also, do you really want to be "gambling" with retirement money?

[sleddog]

I started working on a loan before learning that the rate and fees are unacceptable to me. So the appraisal is done and so is the title search. I should be able to close a loan VERY quickly.

[smallfry]

Message Edited by smallfry on 05-13-2007 09:52 AM

[Noah_Bodie]

Is the money in a Traditional or a Roth? Is it just you, or you and a spouse? What's the total CC debt you want to pay off?

If you're in a Roth, better but not required.

If you're married and your spouse has money in an IRA, that doubles the amount of money you can run thru this plan.

Open a Roth and move some IRA money over to the Roth. If you already have money in a Roth, then you won't have to worry about paying taxes on the conversion from Traditional to Roth. If you don't have a Roth, then you will have to pay taxes when converting the money to a Roth, but in a Roth you don't pay taxes on your earnings when you later make qualified withdrawals. Absent your debt situation, Roth conversions a lot of sense the younger you are.

Take an unqualified withdrawal from the Roth, use it pay down your CCs, refi, then use the money outta your mortgage (I presume you're doing a HELOC) to contribute to your Roth--up to $4K, $5K if you're 50+.

Take a look at Worksheet 2-3 in Publication 590.

http://www.irs.gov/publications/p590/ch02.html#d0e10703

http://www.irs.gov/pub/irs-pdf/p590.pdf

Basically, you can withdraw $4K from your Roth, contribute $4K to your Roth during the year, and you pay no taxes on the distribution. With a spouse, you could each do $4K.

Under this plan, you aren't subject to the 60 day rule on rollovers. You just have to contribute the $4K in the 2007 tax year. Heck, you could withdraw $4K today from a Roth, then contribute $4K to a Roth in December.

[sleddog]

That doesn't help my immediate situation, because the 60 day window applies to rollovers from a traditional IRA even if you put it into a Roth. However, I want to thank you for raising this, because it makes a huge amount of sense to create a Roth and put the money into it rather than into another traditional IRA. You have to wait 5 years, but after that you can take the principal out without penalty and the interest grows tax free. It basically converts money you can't touch without penalty to money you CAN touch, but the balance still grows tax free. Really, this is the way to go with IRAs. Put the money into a regular IRA and get the tax deduction. Every few years move it into a Roth. Because it takes 5 years it isn't an immediate fix, but it makes enormous sense for me to have a chunk of my retirement funds in a Roth. If I had done this 5 years ago, I wouldn't have a problem now. Although hindsight is always 20/20. If I had applied for a home equity line of credit two years ago when I had a FICO of 750, I also wouldn't have had a problem now.

[Kris]

There are tax consequences for moving from a Traditional IRA to a ROTH Conversion IRA.  The Traditional is pre-tax dollars and ROTH is after-tax dollars.   It may make sense in a low income year for a conversion.

If I remember correctly,  money can only be borrowed from IRAs once every 12 months.  I have heard of people getting into trouble so, if you decide to go this route, consult your tax advisor or financial planner.

[Noah_Bodie]

sleddog,

You can move the money into a Roth, and then once it's in the Roth you can then offset unqualified Roth withdrawals with Roth contributions. I don't believe the 5 year rule applies in this case since your contributions to the Roth in essence "protect" the unqualified withdrawal from taxes. However, even if you have to pay taxes on some of it (like if you need to pay down more than $4K in debt, $8K if you're married), I'd crunch some numbers on how much of a better mortgage deal you'll get with the debt gone. That could save you a huge amount of money over time.