Author Topic: Mortgage Payoff w/ PMI Considerations  (Read 3139 times)

ReadySetMillionaire

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Mortgage Payoff w/ PMI Considerations
« on: May 11, 2017, 11:41:46 AM »
I know I am absolutely bludgeoning the living shit out of a dead horse by bringing up this topic again, but I'm curious about how the mortgage payoff debate changes if someone is paying PMI on their mortgage.

By way of background, my fiancee and I bought a house at the end of 2015.  Even though we didn't have 20% down, we thought it would be a good idea to purchase because it was a very "mustachian" purchase--it was way cheaper to own than rent, total purchase price was $127,500 (about the cheapest you could get for a house in this school district), it did not require a lot of repair, it is only 1,050 square feet with a finished basement (meaning low utility costs), and it was the kind of house we could see ourselves in for an incredibly long time.

Because we were somewhat short on cash, we decided to put only 5% down. Our mortgage is $121,500 at an interest rate of 4%.

Our mortgage payment totals $859 per month and breaks down as follows:

$183 to principal
$385 to interest
$183 to property tax
$46 for homeowners' insurance
$63 for PMI

The PMI is obviously an incredible waste and serves absolutely no beneficial purpose.  I've looked at the mortgage and there is no pre-payment penalty, and we are sitting on a bit of cash due to my fiancee recently switching jobs and contributing to our savings account rather than a 401k (she's not eligible for a 401k until the fall). I'd love to get down to 20% equity so we can knock that PMI part off our mortgage payment, which would reduce the mortgage payment to $796. 

My inquiry is how this particular situation applies in the great "mortgage payoff" debate.  My assumption is that getting rid of PMI is in itself somewhat of a return, which means my "return" in getting the mortgage to 20% equity is greater than the 4% interest rate on the mortgage. 

I've run an amortization table, and it looks like if we just make the mortgage payment, we will be paying PMI until December of 2023.  $63/month x 80 months = $5,040. That's a lot to throw away for basically nothing, but I don't know how this lump sum is reflected via a rate-of-return-type of calculation.

I'd love to hear some opinions and/or calculations as to my current situation. Thanks!
« Last Edit: May 11, 2017, 11:49:50 AM by ReadySetMillionaire »

Scortius

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Re: Mortgage Payoff w/ PMI Considerations
« Reply #1 on: May 11, 2017, 11:50:47 AM »
It's a tricky consideration that isn't as clear-cut as it may seem.  I am also in the process of taking out a PMI mortgage... something I never thought I'd do.  One thing that reading this board has taught me is to think more clearly in terms of opportunity cost in regards to investing lump sums in the market.  By putting less money down now, you are able to invest the difference into the market and possibly earn a return on that money in excess of your mortgage rate + PMI.

You say that PMI serves no beneficial purpose, but that's not true.  It allows you to keep a certain amount of liquid money that you can otherwise use to invest.  Or, in the case that you don't have it yet, it means that when you consider the time it would take you to go from where you are to 20%, PMI allows you to invest your savings over that time period instead of putting it into your mortgage principal directly.  It's not a bevy of 'free money', but it's certainly not nothing.

For me, given that rates are low, it doesn't make sense to pay off the PMI as long as I have pre-tax advantaged accounts to invest in.  But, one thing to consider is that my mortgage is larger than yours and my relative PMI payments (when compared to our P&I) are much smaller.  For you, it definitely is a closer decision.  If I were you, I would still prioritize any tax-advantaged accounts and high-interest debts first.  If you still have any money left over, I think it would make sense to push to 22% before investing in taxable brokerage accounts... but that may also depend on your time horizon and volatility tolerance.

You mention an extra cost of $5k over 6 years.  Do you think you can earn more than that plus future interest savings in the market if you invested the money you'd use to pay to 22% instead of putting it into your principal?  If so, invest; if not, pay down the mortgage.

When specifically using the gained opportunity to invest, PMI is the not the pure evil boogyman that many make it out to be.
« Last Edit: May 11, 2017, 03:21:27 PM by Scortius »

Gimesalot

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Re: Mortgage Payoff w/ PMI Considerations
« Reply #2 on: May 11, 2017, 11:51:23 AM »
I don't have any input on the math, but I do have some input on getting rid of PMI early. Lenders are only legal required to remove the PMI on the month that is in your original amortization schedule.  If you pre-pay, make improvements, or house increases in value, you can get an appraisal and request that PMI be removed, but there is no guarantee that the bank will follow through.  I suggest that you research your mortgage company to see their track record.  You can always refinance to get rid of PMI.

Scortius

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Re: Mortgage Payoff w/ PMI Considerations
« Reply #3 on: May 11, 2017, 12:03:55 PM »
I don't have any input on the math, but I do have some input on getting rid of PMI early. Lenders are only legal required to remove the PMI on the month that is in your original amortization schedule.  If you pre-pay, make improvements, or house increases in value, you can get an appraisal and request that PMI be removed, but there is no guarantee that the bank will follow through.  I suggest that you research your mortgage company to see their track record.  You can always refinance to get rid of PMI.

Recent regulations require PMI to be dropped at 78% outstanding, or 22% equity.  That may not apply to older mortgages, so it's definitely worth checking with your lender to get a handle on your situation.  You can try to drop PMI at 20% equity, but that requires a bank-appointed reappraisal which is anything but a guarantee.

Ebrat

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Re: Mortgage Payoff w/ PMI Considerations
« Reply #4 on: May 11, 2017, 02:22:30 PM »
They can request an appraisal, but it's not automatically required. At 78% they have to cancel it automatically (given the loan is in good standing, etc.).

I've spent a lot of time thinking about this. A few considerations:

You're paying PMI to borrow the difference between 5% and 15%. For you, that was initially about $19k. This means that

1) the interest rate on that $19k was 4% plus $63/mo when you got the loan, or about 8% altogether

2) the more of the principal you pay down, the higher the effective interest rate on the portion of the loan that you're paying PMI for. For example, at 85% equity, you're paying PMI on the difference between 80 and 85% equity, or about $6,400. So you're paying about 4+12=16% to borrow that $6,400.

3) The closer you are to getting to 80%, the more sense it might make to pay a lump sum to get rid of PMI. For example, I have a house with PMI left for another 3.5 years or so. If I paid a lump sum right now to get rid of it, I'd save about $60/month for the next 3.5 years. But that lump sum would then be tied up in the house instead of invested, so over the loan payoff period I come out ahead by eating the PMI now and leaving the money invested. I plan to keep the house long-term and not refinance; changing either of these things would change the numbers.

What I did was create a spreadsheet that has a payoff schedule using the minimum payments and a payoff schedule using a lump sum to get rid of PMI. Then you can look at when the loan will be paid off and how much you'll pay in interest and PMI in each scenario, and compare that to how much you would expect the lump sum to earn over that time period (remember to also factor in investing the PMI payments in the lump sum scenario and the mortgage payments between when the loan is paid off in the lump sum scenario and the normal payoff).

Anyway, hope that makes sense, but that's been my thinking on the matter. We're keeping the PMI for now.

ReadySetMillionaire

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Re: Mortgage Payoff w/ PMI Considerations
« Reply #5 on: May 12, 2017, 06:07:45 AM »
They can request an appraisal, but it's not automatically required. At 78% they have to cancel it automatically (given the loan is in good standing, etc.).

I've spent a lot of time thinking about this. A few considerations:

You're paying PMI to borrow the difference between 5% and 15%. For you, that was initially about $19k. This means that

1) the interest rate on that $19k was 4% plus $63/mo when you got the loan, or about 8% altogether

2) the more of the principal you pay down, the higher the effective interest rate on the portion of the loan that you're paying PMI for. For example, at 85% equity, you're paying PMI on the difference between 80 and 85% equity, or about $6,400. So you're paying about 4+12=16% to borrow that $6,400.

3) The closer you are to getting to 80%, the more sense it might make to pay a lump sum to get rid of PMI. For example, I have a house with PMI left for another 3.5 years or so. If I paid a lump sum right now to get rid of it, I'd save about $60/month for the next 3.5 years. But that lump sum would then be tied up in the house instead of invested, so over the loan payoff period I come out ahead by eating the PMI now and leaving the money invested. I plan to keep the house long-term and not refinance; changing either of these things would change the numbers.

What I did was create a spreadsheet that has a payoff schedule using the minimum payments and a payoff schedule using a lump sum to get rid of PMI. Then you can look at when the loan will be paid off and how much you'll pay in interest and PMI in each scenario, and compare that to how much you would expect the lump sum to earn over that time period (remember to also factor in investing the PMI payments in the lump sum scenario and the mortgage payments between when the loan is paid off in the lump sum scenario and the normal payoff).

Anyway, hope that makes sense, but that's been my thinking on the matter. We're keeping the PMI for now.

Thanks for this.  My original post could have been more simple in that my biggest query is how to calculate the rate of return. Your post explains this quite well, so thank you.

Ebrat

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Re: Mortgage Payoff w/ PMI Considerations
« Reply #6 on: May 12, 2017, 03:44:41 PM »
Yay! Happy I could help :)

RedmondStash

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Re: Mortgage Payoff w/ PMI Considerations
« Reply #7 on: May 12, 2017, 08:40:16 PM »
FWIW, we avoided PMI on our first mortgage by simultaneously taking out a second mortgage instead. It had a higher interest rate than our first mortgage, but paying it off was entirely within our control, and we got rid of it with our first refinance. I really hate PMI.

PMI isn't the only option when you don't have 20% to put down.

 

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