Author Topic: Should I quickly pay down my mortgage to eliminate PMI?  (Read 2051 times)

Longwell

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Should I quickly pay down my mortgage to eliminate PMI?
« on: September 11, 2018, 11:57:56 AM »
I am trying to figure out if I should put down extra cash to get out of PMI or just eat the fees and invest the money instead. I tried figuring this out myself with an average return of 6% and to me it kind of looks like a wash or it leaning slightly to paying down the PMI as being the right decision but I want some input.

Current Mortgage Balance: $196,815
Balance needed to get rid of PMI: $173,120
Difference: $23,695

My PMI costs me $100 a month.
  • After taxes, interest, etc I am currently able to pay down the principal by $875 a month. This means that it will take me 27 months, with $2700 in extra PMI payments (wasted money)
  • I am considering putting down $1500 a month (plus whatever other money I get from sidegigs). This would take me roughly 12-15 months or only $1200-1500 in PMI payments, eliminating around $1500 in PMI payments from the first option

So do I try to pay down the PMI as aggressively as possible and then switch over to investing? Or do I keep the course and just pay it down the way I have been while investing the rest? Thanks for any help in advance!

nedwin

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #1 on: September 12, 2018, 09:43:13 AM »
Are you able to eliminate PMI based on appreciation without paying down the mortgage balance?  I was able to eliminate PMI because of appreciation,  I only had to pay for new appraisal ($400?).

terrifictim

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #2 on: September 12, 2018, 10:49:20 AM »
I second the advice of nedwin. My fiancee was in a similar type situation- would have needed to put ~$15,000 in principal down in order to remove the PMI. Instead we got it reappraised and were able to get the PMI removed for the appraisal fee of $425. The two conditions for this process for our lender was: no late payments, needed to be in the property for a minimum of two years. It's worth asking your vendor if you qualify to remove the PMI with a reappraisal. Also - this also assumes that your property has appraised enough to hit the 80% LTV.

Dicey

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #3 on: September 15, 2018, 10:52:49 AM »
If PMI is the only way you could have gotten in to this property, then just embrace it and be glad it was available to you. Everybody with less than 20% down is happy to get a loan with PMI, and then they promptly despise it.

You can increase the value of your home by making wise DIY improvements, and by just plain waiting for the housing market to improve. Given enough time, PMI cures itself even if you do nothing. Not a terrible deal.

Typically, it's better to invest your surplus into the stock market than your mortgage, if it's just for the purpose of killing PMI. For more on this subject, check out this thread:

https://forum.mrmoneymustache.com/throw-down-the-gauntlet/dont-payoff-your-mortgage-club/

Longwell

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #4 on: October 02, 2018, 07:30:17 AM »
I second the advice of nedwin. My fiancee was in a similar type situation- would have needed to put ~$15,000 in principal down in order to remove the PMI. Instead we got it reappraised and were able to get the PMI removed for the appraisal fee of $425. The two conditions for this process for our lender was: no late payments, needed to be in the property for a minimum of two years. It's worth asking your vendor if you qualify to remove the PMI with a reappraisal. Also - this also assumes that your property has appraised enough to hit the 80% LTV.

This sounds like a great idea. My only concern is could the reassessment possibly raise my taxes?

EDIT: So I just called Wells Fargo and they said that there is no way to get PMI removed unless you have 20% equity in the house. So it sounds like perhaps this isn't an option for me.
« Last Edit: October 02, 2018, 07:52:10 AM by Longwell »

nedwin

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #5 on: October 02, 2018, 09:40:33 AM »
What type of loan do you have?  FHA?  Conventional?  The answer will have an impact on how (and if) you can eliminate PMI early.

Did you ask Wells Fargo if you could establish 20% equity by having your home re-appraised?

A new appraisal should not have an affect on your property taxes, as they are generally not reported to the local tax assessor.

Longwell

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #6 on: October 02, 2018, 11:57:41 AM »
What type of loan do you have?  FHA?  Conventional?  The answer will have an impact on how (and if) you can eliminate PMI early.

Did you ask Wells Fargo if you could establish 20% equity by having your home re-appraised?

A new appraisal should not have an affect on your property taxes, as they are generally not reported to the local tax assessor.

I just have a standard 30 year mortgage.

That was the exact question I asked them, if it was possible for PMI to be removed by having my home re-appraised. I guess it's possible that I didn't explain what I was asking properly or the person just didn't know.

Treeclimber65

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #7 on: October 03, 2018, 03:00:49 AM »
I'm think you should call Wells Fargo back.  I just did exactly this with my Wells Fargo mortgage in June.  Had it re-appraised based on increased value and had the PMI removed.  Wells Fargo even offered me a special program and I did not have to pay for a full priced appraisal.  Instead, a real estate agent did it and it only cost me $200.00.

terrifictim

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #8 on: October 03, 2018, 08:08:59 AM »
Just did a quick google search (https://www.wellsfargo.com/mortgage/manage-account/insurance/mortgage-insurance/how-to-remove-mortgage-insurance/).

------------------------------
Quote
Canceling PMI
For loans covered by the Homeowners Protection Act of 1998 (HPA), you can request to have PMI removed when your balance reaches 80% loan-to-value (LTV) based on the original value of your home. If you're requesting to have PMI removed, you:

Have to get a home value assessment through Wells Fargo (at your own expense) to confirm your home's value hasn't declined since closing
Must not have had any 30-day late payments within the past 12 months
Must not have had any 60-day late payments within the last 24 months
Otherwise, we'll automatically cancel it when your balance reaches 78% LTV if you're up to date on your payments.

If your home's value went up since closing, you may be able to cancel your PMI earlier, based on its current value. In some cases this can happen if you've made significant improvements to your home. You'll need to get a home value assessment to confirm its value. The guidelines don't apply to every loan so be sure to call us at 1-800-357-6675 to get the specifics on when you can remove your PMI. See our FAQs to learn more.

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #9 on: October 08, 2018, 12:45:13 PM »
$23,695.00 if invested would net $1,850.00 annually in the market, or about $157.00 each month.  (Assuming 8% growth for simplicity, and ignoring exponential gains).

While PMI is annoying, you are at a loss the instant you pay extra.  Significantly more so once you account for 30-Year opportunity loss, compound gains, and the variable of interest rate vs market rate on the funds.

If you can do it for the price of an appraisal (~$400), knock yourself out.  Otherwise, you have to get to 78% LTV which will cost you money you can never get back.

The math says no.

Longwell

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #10 on: October 09, 2018, 09:51:31 AM »
I'm think you should call Wells Fargo back.  I just did exactly this with my Wells Fargo mortgage in June.  Had it re-appraised based on increased value and had the PMI removed.  Wells Fargo even offered me a special program and I did not have to pay for a full priced appraisal.  Instead, a real estate agent did it and it only cost me $200.00.

Did you do significant renovations to your home or was it just an increase of your house value in the market? Like supposedly according to Redfin my house is worth $60K more than I paid for it, but obviously who know's how accurate that is.

thd7t

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #11 on: October 09, 2018, 10:26:44 AM »
$23,695.00 if invested would net $1,850.00 annually in the market, or about $157.00 each month.  (Assuming 8% growth for simplicity, and ignoring exponential gains).

While PMI is annoying, you are at a loss the instant you pay extra.  Significantly more so once you account for 30-Year opportunity loss, compound gains, and the variable of interest rate vs market rate on the funds.

If you can do it for the price of an appraisal (~$400), knock yourself out.  Otherwise, you have to get to 78% LTV which will cost you money you can never get back.

The math says no.
The math says yes.  The pmi is costing $1200/year and the interest on the portion of the loan that carries pmi ($23,695) is $710 @ 3% interest.  At 3% interest on the loan, paying off PMI beats 8% returns.

PMI can't be treated like interest added to the cost of the whole loan.  It's only applied to the top 20%.

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #12 on: October 09, 2018, 11:16:28 AM »
$23,695.00 if invested would net $1,850.00 annually in the market, or about $157.00 each month.  (Assuming 8% growth for simplicity, and ignoring exponential gains).

While PMI is annoying, you are at a loss the instant you pay extra.  Significantly more so once you account for 30-Year opportunity loss, compound gains, and the variable of interest rate vs market rate on the funds.

If you can do it for the price of an appraisal (~$400), knock yourself out.  Otherwise, you have to get to 78% LTV which will cost you money you can never get back.

The math says no.
The math says yes.  The pmi is costing $1200/year and the interest on the portion of the loan that carries pmi ($23,695) is $710 @ 3% interest.  At 3% interest on the loan, paying off PMI beats 8% returns.

PMI can't be treated like interest added to the cost of the whole loan.  It's only applied to the top 20%.

Correct....  However any early payments made now must be carried through the life of the loan.  The lost opportunity cost will remain for 30 years (or whatever slightly shorter remaining loan time is applied) as well as indefinitely into the future due to lost time to compound things.

Thats why not paying it off wins long term, because operating on margin the gains are that big compared to spending PMI.

The actual gains including compounding on only the 23k above is 261,125.49 for 30 years.
The gains from paying off the mortgage to reduce pmi on 23k at 3% is 58,214.88 PLUS 100$ a month for approx. 101 payments (unsure original as OP hasn't provide full loan data) is an additional $10,100.00 for a TOTAL OF $68,314.88 in savings.

Lost Opportunity of $261,125.49
is greater than
Savings of $68,314.88


Paying off a 3% fixed 30-year loan early, even to remove PMI, does not make financial sense....
In this case it makes $192,810.61 worth less sense....

@Longwell , I hope your paying attention.  I was in your shoes.

thd7t

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #13 on: October 09, 2018, 11:28:36 AM »
TexasRunner, nice analysis.  Wouldn't you want to assume that the $100/month would be invested, though?  Over 30 years, that returns $136,000 in addition to the $68,000.  That brings us to $204,000. 

Still not as good, but we don't know OP's mortgage rate and I skewed the number lower than a new 30 year mortgage could possibly be.

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #14 on: October 09, 2018, 11:34:30 AM »
TexasRunner, nice analysis.  Wouldn't you want to assume that the $100/month would be invested, though?  Over 30 years, that returns $136,000 in addition to the $68,000.  That brings us to $204,000. 

Still not as good, but we don't know OP's mortgage rate and I skewed the number lower than a new 30 year mortgage could possibly be.

You are correct, but (similar to my first post) I try to simplify and stay out of the weeds.  While it does increase the gains from holding the mortgage, you can lose viewers of the forest due to the trees.

We also should account for inflation (taking my 8% to a lofty 10%) as well as investing the PMI 100$ per month (which would reduce some things, but nowhere near the level of a 4% fixed margin), also tax benefits from mortgage interest, and risk of eviction (banker has to evict one of two people, same value house in the same area, one owes 300k and the other owes 150k, who do you think he will pick in a down market...?) etc.  Essentially, KISS to prove the point since all the smaller factors will only adjust the end result, not change it.
« Last Edit: October 09, 2018, 11:36:04 AM by TexasRunner »

thd7t

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #15 on: October 09, 2018, 11:41:22 AM »
TexasRunner, nice analysis.  Wouldn't you want to assume that the $100/month would be invested, though?  Over 30 years, that returns $136,000 in addition to the $68,000.  That brings us to $204,000. 

Still not as good, but we don't know OP's mortgage rate and I skewed the number lower than a new 30 year mortgage could possibly be.

You are correct, but (similar to my first post) I try to simplify and stay out of the weeds.  While it does increase the gains from holding the mortgage, you can lose viewers of the forest due to the trees.

We also should account for inflation (taking my 8% to a lofty 10%) as well as investing the PMI 100$ per month (which would reduce some things, but nowhere near the level of a 4% fixed margin), also tax benefits from mortgage interest, and risk of eviction (banker has to evict one of two people, same value house in the same area, one owes 300k and the other owes 150k, who do you think he will pick in a down market...?) etc.  Essentially, KISS to prove the point since all the smaller factors will only adjust the end result, not change it.
I agree that we shouldn't get too into the details, but not comparatively investing dramatically skewed the results in an unrealistic way and it ignored OP's question about when to invest.  With the math relatively close (Not nearly $200k different), they should input their real numbers and find a real answer, now.

FIPurpose

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #16 on: October 09, 2018, 12:00:11 PM »
$23,695.00 if invested would net $1,850.00 annually in the market, or about $157.00 each month.  (Assuming 8% growth for simplicity, and ignoring exponential gains).

While PMI is annoying, you are at a loss the instant you pay extra.  Significantly more so once you account for 30-Year opportunity loss, compound gains, and the variable of interest rate vs market rate on the funds.

If you can do it for the price of an appraisal (~$400), knock yourself out.  Otherwise, you have to get to 78% LTV which will cost you money you can never get back.

The math says no.
The math says yes.  The pmi is costing $1200/year and the interest on the portion of the loan that carries pmi ($23,695) is $710 @ 3% interest.  At 3% interest on the loan, paying off PMI beats 8% returns.

PMI can't be treated like interest added to the cost of the whole loan.  It's only applied to the top 20%.

Correct....  However any early payments made now must be carried through the life of the loan.  The lost opportunity cost will remain for 30 years (or whatever slightly shorter remaining loan time is applied) as well as indefinitely into the future due to lost time to compound things.

Thats why not paying it off wins long term, because operating on margin the gains are that big compared to spending PMI.

The actual gains including compounding on only the 23k above is 261,125.49 for 30 years.
The gains from paying off the mortgage to reduce pmi on 23k at 3% is 58,214.88 PLUS 100$ a month for approx. 101 payments (unsure original as OP hasn't provide full loan data) is an additional $10,100.00 for a TOTAL OF $68,314.88 in savings.

Lost Opportunity of $261,125.49
is greater than
Savings of $68,314.88


Paying off a 3% fixed 30-year loan early, even to remove PMI, does not make financial sense....
In this case it makes $192,810.61 worth less sense....

@Longwell , I hope your paying attention.  I was in your shoes.

I think your analysis is off; I don't see where you add in the opportunity cost for the saved PMI. As in, you compound the 23k over 30 years, but didn't compound the PMI savings

It looks like you're using a 12% stock return which is probably a bit much, but even so the saved $10,000 in PMI will negate about $115k of your estimate.

23k in stock  compounded @10% = 177k

Interest savings (your number) = 58k
PMI savings + opportunity cost = 10k + 77k

177k - 145k = 32k

Over 30 years, there isn't a huge difference, but the closer you get to paying down to 80%, the better it's going to look since it's a flat payment.

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #17 on: October 09, 2018, 03:45:20 PM »
$23,695.00 if invested would net $1,850.00 annually in the market, or about $157.00 each month.  (Assuming 8% growth for simplicity, and ignoring exponential gains).

While PMI is annoying, you are at a loss the instant you pay extra.  Significantly more so once you account for 30-Year opportunity loss, compound gains, and the variable of interest rate vs market rate on the funds.

If you can do it for the price of an appraisal (~$400), knock yourself out.  Otherwise, you have to get to 78% LTV which will cost you money you can never get back.

The math says no.
The math says yes.  The pmi is costing $1200/year and the interest on the portion of the loan that carries pmi ($23,695) is $710 @ 3% interest.  At 3% interest on the loan, paying off PMI beats 8% returns.

PMI can't be treated like interest added to the cost of the whole loan.  It's only applied to the top 20%.

Correct....  However any early payments made now must be carried through the life of the loan.  The lost opportunity cost will remain for 30 years (or whatever slightly shorter remaining loan time is applied) as well as indefinitely into the future due to lost time to compound things.

Thats why not paying it off wins long term, because operating on margin the gains are that big compared to spending PMI.

The actual gains including compounding on only the 23k above is 261,125.49 for 30 years.
The gains from paying off the mortgage to reduce pmi on 23k at 3% is 58,214.88 PLUS 100$ a month for approx. 101 payments (unsure original as OP hasn't provide full loan data) is an additional $10,100.00 for a TOTAL OF $68,314.88 in savings.

Lost Opportunity of $261,125.49
is greater than
Savings of $68,314.88


Paying off a 3% fixed 30-year loan early, even to remove PMI, does not make financial sense....
In this case it makes $192,810.61 worth less sense....

@Longwell , I hope your paying attention.  I was in your shoes.

I think your analysis is off; I don't see where you add in the opportunity cost for the saved PMI. As in, you compound the 23k over 30 years, but didn't compound the PMI savings

It looks like you're using a 12% stock return which is probably a bit much, but even so the saved $10,000 in PMI will negate about $115k of your estimate.

23k in stock  compounded @10% = 177k

Interest savings (your number) = 58k
PMI savings + opportunity cost = 10k + 77k

177k - 145k = 32k

Over 30 years, there isn't a huge difference, but the closer you get to paying down to 80%, the better it's going to look since it's a flat payment.

You are right.  The 'smallness' of the loan and the investment opportunity to make things get closer together than normal.  I was using 8% return on stocks.
If we account for inflation as well, the numbers turn out as follows:


The actual gains including compounding on only the 23k above is 261,125.49 for 30 years. (at 8% annual rate).

The gains from paying off the mortgage to reduce pmi on 23k at 3% is 58,214.88 PLUS 100$ a month for approx. 101 payments (unsure original as OP hasn't provide full loan data) is an additional $10,100.00.  However, saving $10,100 isn't small potatoes and the PMI not paid (gains because it wasn't paid) invested for 30 years at 8% will net $80,189.53 at the end of 30 years.  However, you will lose 12,900 in payments that would have been inflation delayed across 360 months, at a average inflation rate of 3.22%, which is another net loss of 20,992.19 (33,892.19 - initial 'principal' of 12,900 un-inflated dollars) that could have been paid with future dollars but wasn't.  I am excluding 'savings' from not 'spending' PMI out of that number, or else it would have been higher. 

Lost Opportunity of $261,125.49
is greater than
Savings of $117,412.22 ($58,214.88 + 80,189.53 - 20,992.19)
<$143,713.27 NET LOSS>

If you don't care about inflation, then its:
Lost Opportunity of $261,125.49
is greater than
Savings of $138,404.41 ($58,214.88 + 80,189.53)
<$122,721.08 NET LOSS>

So you will lose $143,713.27 across 30 years if you prepay or, alternatively, if you want to plug your fingers in your ears and ignore inflation, you can lose $122,721.08 across 30 years.

Thats (nearly) enough to put a kid through college.
Almost enough to buy another house in cash.
Buy a couple of Tesla Model S for retirement...

Pretending that it a large sum of money, and that 'you can just work for another year to make up for it' is really terrible financial planning.  Especially on a FIRE forum.

FIPurpose

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #18 on: October 09, 2018, 04:25:24 PM »
I think you have one more adjustment to make.

You're using pre-tax dollars in your investment comparison. You'll need to estimate at least some of that money has to go to taxes in both capital gains and in your compounding estimates.

If he's debating between paying off PMI or contributing to his 401k the the answer is obviously 401k.

Treeclimber65

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #19 on: October 10, 2018, 04:37:22 AM »
Did you do significant renovations to your home or was it just an increase of your house value in the market? Like supposedly according to Redfin my house is worth $60K more than I paid for it, but obviously who know's how accurate that is.

This is a relatively new property so no renovations. I had it reappraised based on increased value. Zillow had it valued at an amount that brought it above 20 percent equity. I was lucky in a way because it is a townhouse and two essentially identical townhouses had sold for Zillow's valuation, so I thought it was worth the risk. Wells Fargo offering to do the appraisal for $200 didn't hurt. In our case, Zillow's value was right on the money, but of course that can vary widely from home to home. 

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #20 on: October 10, 2018, 09:36:06 AM »
Did you do significant renovations to your home or was it just an increase of your house value in the market? Like supposedly according to Redfin my house is worth $60K more than I paid for it, but obviously who know's how accurate that is.

This is a relatively new property so no renovations. I had it reappraised based on increased value. Zillow had it valued at an amount that brought it above 20 percent equity. I was lucky in a way because it is a townhouse and two essentially identical townhouses had sold for Zillow's valuation, so I thought it was worth the risk. Wells Fargo offering to do the appraisal for $200 didn't hurt. In our case, Zillow's value was right on the money, but of course that can vary widely from home to home.

Congrats on getting rid of your pmi.  Re-appraisal definitely seems like the way to go.  I am glad OP started this thread, because it reminded me I need to have the house re-appraised to get rid of PMI as well.  Pay off app vs PMI is about 3 months for me, then its profit.

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #21 on: October 10, 2018, 09:38:22 AM »
I think you have one more adjustment to make.

You're using pre-tax dollars in your investment comparison. You'll need to estimate at least some of that money has to go to taxes in both capital gains and in your compounding estimates.

If he's debating between paying off PMI or contributing to his 401k the the answer is obviously 401k.

Ok, so slice the compounding by a maximum of 15% of the gains and your still thousands of dollars ahead by not paying it down...

Treeclimber65

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #22 on: October 12, 2018, 03:45:10 AM »
Congrats on getting rid of your pmi.  Re-appraisal definitely seems like the way to go.  I am glad OP started this thread, because it reminded me I need to have the house re-appraised to get rid of PMI as well.  Pay off app vs PMI is about 3 months for me, then its profit.

Sooner the better!  I realized after the fact that I could have done this at least a year and probably 18 months sooner.  That's quite a few dollars I wasted.

genesismachine

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #23 on: October 19, 2018, 04:30:59 PM »
The PMI/interest likely won't be tax deductible due to the recent Trump boosting of the standard deduction, but there will be capital gains tax on future stock appreciation from investing elsewhere. This causes the numbers to likely be a wash, or at least very close.

But the return on this is risk-free, while the return on other investments is not. If you're ever given the choice between a 10% guaranteed return vs a 10% *average* risky return, investment theory says you should always pick the guaranteed return. This is why risk premiums exist. You are not being compensated for your added risk in this case with higher average expected returns.

Further, you will be gaining another $100/month in free cash flow, which will add to your optionality in case you see other investment opportunities (although it is so small it probably won't add much). One thing you could do with the extra $100/month is to put it into a 401k.

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #24 on: October 19, 2018, 05:49:06 PM »
The PMI/interest likely won't be tax deductible due to the recent Trump boosting of the standard deduction, but there will be capital gains tax on future stock appreciation from investing elsewhere. This causes the numbers to likely be a wash, or at least very close.

Nope nope nope nope no nope no.  The Mortgage deduction for interest is only <EFFECTIVE RATE> x Interest Paid.  He would still be paying interest and in the (very unlikely) event that he gets to itemize, there is still some interest to put on there, but it is minimal.  The Tax on gains however is only on Taxable Gains (IE DIVIDENDS) at 15%, again a very small amount.  With 8000k, As of December 2017, the dividend yield for the S&P 500 was 1.85%, that leads to $22.20 in additional taxes.  (8000 x 1.85% x 15% tax rate).  IT IS A TINY AMOUNT.  Giving up compounding on investments for 22$ in 'tax gains' because you chose not to invest is asinine. It is nowhere near a wash, as noted above.  @genesismachine please do the math and understand what is given up by pre-paying before giving advice. This is exactly why the DPOYM Club exists, because #fakemath calling things a wash leads people astray.

But the return on this is risk-free, while the return on other investments is not. If you're ever given the choice between a 10% guaranteed return vs a 10% *average* risky return, investment theory says you should always pick the guaranteed return. This is why risk premiums exist. You are not being compensated for your added risk in this case with higher average expected returns.

Again, not a 10% gain.  If it were we would all be telling him to pay it off as fast as possible (or better yet re-mortgage for a better rate) because the math doesn't make sense at 10% to keep the mortgage.  It does, however, make sense at 3%.  Again, saying that paying down the mortgage is a guaranteed 10% is #fakemath and leads people astray.

Further, you will be gaining another $100/month in free cash flow, which will add to your optionality in case you see other investment opportunities (although it is so small it probably won't add much). One thing you could do with the extra $100/month is to put it into a 401k.

If he isn't (and if you aren't) maxing out your 401k BEFORE paying any extra on a long-term low fixed rate loan, you are WASTING MONEY left and right.  Tax free depositing and gains in a 401k will ABSOLUTELY DEMOLISH the so-called 'return' on a mortgage.  At a bare minimum, fill up your tax-free buckets before paying any extra on a low rate loan. 

Beyond that, the extra 100$ obviously doesn't matter if he has extra thousands of dollars to get rid of PMI.  The little green soldiers need to be used the most effectively we can, not Russia WWII style marching them by the thousands into battle without rifles to get rid of a secure low-rate loan that can't be called while Moscow burns ...  (Little green soldiers is money, battle is PMI and loan extra payments, Moscow is tax free accounts ;) )

In all seriousness, this forum is supposed to be about optimizing and reducing consumption.  There is nothing optimal about paying down a mortgage early while leaving space (that is lost FOREVER) in a 401k...

genesismachine

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #25 on: October 19, 2018, 11:17:25 PM »
The PMI/interest likely won't be tax deductible due to the recent Trump boosting of the standard deduction, but there will be capital gains tax on future stock appreciation from investing elsewhere. This causes the numbers to likely be a wash, or at least very close.

Nope nope nope nope no nope no.  The Mortgage deduction for interest is only <EFFECTIVE RATE> x Interest Paid.  He would still be paying interest and in the (very unlikely) event that he gets to itemize, there is still some interest to put on there, but it is minimal.  The Tax on gains however is only on Taxable Gains (IE DIVIDENDS) at 15%, again a very small amount.  With 8000k, As of December 2017, the dividend yield for the S&P 500 was 1.85%, that leads to $22.20 in additional taxes.  (8000 x 1.85% x 15% tax rate).  IT IS A TINY AMOUNT.  Giving up compounding on investments for 22$ in 'tax gains' because you chose not to invest is asinine. It is nowhere near a wash, as noted above.  @genesismachine please do the math and understand what is given up by pre-paying before giving advice. This is exactly why the DPOYM Club exists, because #fakemath calling things a wash leads people astray.

But the return on this is risk-free, while the return on other investments is not. If you're ever given the choice between a 10% guaranteed return vs a 10% *average* risky return, investment theory says you should always pick the guaranteed return. This is why risk premiums exist. You are not being compensated for your added risk in this case with higher average expected returns.

Again, not a 10% gain.  If it were we would all be telling him to pay it off as fast as possible (or better yet re-mortgage for a better rate) because the math doesn't make sense at 10% to keep the mortgage.  It does, however, make sense at 3%.  Again, saying that paying down the mortgage is a guaranteed 10% is #fakemath and leads people astray.

Further, you will be gaining another $100/month in free cash flow, which will add to your optionality in case you see other investment opportunities (although it is so small it probably won't add much). One thing you could do with the extra $100/month is to put it into a 401k.

If he isn't (and if you aren't) maxing out your 401k BEFORE paying any extra on a long-term low fixed rate loan, you are WASTING MONEY left and right.  Tax free depositing and gains in a 401k will ABSOLUTELY DEMOLISH the so-called 'return' on a mortgage.  At a bare minimum, fill up your tax-free buckets before paying any extra on a low rate loan. 

Beyond that, the extra 100$ obviously doesn't matter if he has extra thousands of dollars to get rid of PMI.  The little green soldiers need to be used the most effectively we can, not Russia WWII style marching them by the thousands into battle without rifles to get rid of a secure low-rate loan that can't be called while Moscow burns ...  (Little green soldiers is money, battle is PMI and loan extra payments, Moscow is tax free accounts ;) )

In all seriousness, this forum is supposed to be about optimizing and reducing consumption.  There is nothing optimal about paying down a mortgage early while leaving space (that is lost FOREVER) in a 401k...

Ok, let's do some math.

The standard deduction for 2018 is $24k for married couples. With the numbers provided, it is highly unlikely that any part of the interest/mortgage insurance will be tax deductible for OP.

Rough numbers: $25k @ 3% interest + $100/month avoided = $1950/yr saved, ~7.8% risk free return

Now, that does seem under the long term stock market AVERAGE return. Forget about the tax on dividends because that's a tiny amount like you said. Eventually, you will be withdrawing the amount, right? In my state, I would be dealing with 15% federal tax rate + 10% state tax rate. Not sure about OP.

So to make $1950/yr from a $25k investment AFTER TAX, with a 25% rate, we would actually need to earn a 10.4% return RISK FREE if we were to compare apples to apples against a pure S&P 500 investment.

Now, let's take on the actual S&P 500 with dividend reinvestment over the last 50 years as a baseline:
https://dqydj.com/sp-500-return-calculator/

I got 10.02% return with dividend reinvestment from 1968-2018, which I think is a good baseline.

Now, would you rather have a 10.4% risk free return or a 10.02% risky return? It seems you may not understand how investment theory works if you think the second option is better.

But actually, it gets even worse for your point when you take into account that you could take that $1950/yr and invest it in the S&P 500 too. Using this compound interest calculator, and entering the following:
http://moneychimp.com/calculator/compound_interest_calculator.htm
Initial principal: $0
Years to grow: 10
Interest Rate (S&P 500 historical 50 year return including dividend reinvestment): 10.02%
Future Value: $34,224 ($59224 when you include the initial $25k)

Calculate the compound return: $(59224/25000)^(1/10) = 9% return

When accounting for tax rates, it gets a little more complicated since some (the stock market gains) is taxable while some (the interest/mortgage insurance avoided) isn't. This takes it to an 'adjusted' after tax return of 8.3%

Comparing apples to apples, that would mean the pure S&P 500 investment would have to return 11.08% RISK FREE. This is significantly above the 10.02% average return. And again, one is RISK FREE while the other is not. There is a concept called risk premium that says that you should be taking a smaller return in exchange for less risk/volatility. So if you believe in basic investment theory, you would need to have a return far in excess of 10.02% to compensate you for that risk, and that is unlikely to happen based on the past 50 years history.

So I would actually say that my math is just fine, and these numbers agree with what I posted earlier.

Now, paying off the remainder of the mortgage is a much more controversial move... I am by no means a proponent of paying off a 3% mortgage.

Disclaimer: Technically you would've eventually paid off the mortgage principal enough to get rid of PMI automatically at some point. I just used 10 years as a rough number for default payoff time. I admit I did simplify some of the math, not accounting for the wide range of possibilities (we could've had much more than 10.02% S&P 500 returns, or much less, thus the volatility). The numbers may change slightly depending on state tax rates and exact personal circumstances, and future tax rates (capital gains tax rates have changed many times throughout US history), but the general point holds in almost all imaginable circumstances.

TexasRunner

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #26 on: October 20, 2018, 10:45:20 AM »
Except you can't back out extra payments, so you need to be considering the remaining term on the loan - an additional 28 Years.

OP is likely not in the 25% tax bracket (again, see higher standard deduction). Much more likely he is in the 12% or 22% bracket (married filing jointly), and you need to use effective tax rate, not nominal.  Also note:  If he isn't maxing out 401k for him and his spouse, and maxing out ROTHs then there are additional TAX FREE dollars there.  So in those instances not only would taxes not apply, they would reduce his tax burden.

Also, you are not accounting for inflation.  S&P numbers include inflation, the mortgage does not.

Feel free to read the whole thread or revise your numbers.

genesismachine

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Re: Should I quickly pay down my mortgage to eliminate PMI?
« Reply #27 on: October 20, 2018, 03:09:13 PM »
Except you can't back out extra payments, so you need to be considering the remaining term on the loan - an additional 28 Years.

OP is likely not in the 25% tax bracket (again, see higher standard deduction). Much more likely he is in the 12% or 22% bracket (married filing jointly), and you need to use effective tax rate, not nominal.  Also note:  If he isn't maxing out 401k for him and his spouse, and maxing out ROTHs then there are additional TAX FREE dollars there.  So in those instances not only would taxes not apply, they would reduce his tax burden.

Also, you are not accounting for inflation.  S&P numbers include inflation, the mortgage does not.

Feel free to read the whole thread or revise your numbers.

If you went to the link I provided, you'd see the S&P 500 numbers I provided are not factoring inflation. If you factor inflation with dividends reinvested, it drops the annual return to 5.78%, not the 10.02% I quoted.

I would actually argue that you would have to use nominal tax rates since this is adding on top of whatever he has already saved. Personally when I am trying to calculate the effect of an additional choice (on top of what I'm already doing), I use the nominal rate (the rate for tax on top of what I'm already doing), I would not average it in. But this is debatable depending on how you frame it.

You might be confusing long term capital gains tax rates with rates on earned income. There is no 12% or 22% tax bracket for long term capital gains. The rates are 0%, 15% and 20%. His personal income tax rate doesn't enter into this conversation (due to high standard deduction), and later he will be paying long term capital gains tax, not income tax.

But those are just details. What you're essentially saying is that 'risk premium' should not exist. If the long term return of the S&P 500 is 10%, then by that logic, all bonds should be returning 10% on the dot. This is very much in the face of virtually all investment knowledge. If we assume US government bonds to be as close to risk free as is possible, we see that 30 year bond notes are currently trading at 3.38% yield. Nowhere near 10%. This implies a 30 year risk premium of 6.62%, not 0%. One could argue that 6.62% may be too much or too little depending on the exact scenario, but I don't think anyone would argue it should be 0%. It's hard to overstate how much of an outsider opinion that is.

I feel like this is a religion and no amount of evidence will suffice...
« Last Edit: October 20, 2018, 03:23:31 PM by genesismachine »