Mortgage Payment - To Eliminate PMI

[Chiron]

Hi everyone,

I'm new to the MMM community.  I've read quite a few of the blog articles and think the general philosphy is great.  I have a decision coming up and am wondering what everyone's take on my thinking is.

I am considering making a large principal payment on my mortgage to eliminate PMI.   I'm assuming I'll stay in my house for 8 years.  This would require making a $36k payment next month.  I would save $137/month in PMI for the next 86 months (when my mortgage would naturally hit 80% LTV assuming no appreciation).  I would also save ~$8k in interest over that time period after backing out my tax deduction.  Thus, my total savings would be (137*86)+8000 = $19,782. 

The alternative is to put the $36k in a brokerage account and buy index funds (I'm set on emergency fund and tax advantaged accounts).  Assuming that grows at a 6.8% rate, I will have $24,935 in gains after 8 years.  Subtracting 20% capital gains tax leaves me with $19,948 - about the same as the other scenario.  The break-even return in these circumstances seems to be around a 6.8-7% return.

First question - is my math correct?  Are there any unreasonable assumptions here?

Second question - it seems obvious to me to make the payment and take the guaranteed ~7% return rather than attempt to beat that return by investing.  I understand that historically equities have performed slightly higher than this, but the marginal difference is far from guaranteed.  A friend is trying to convince me I can beat that in the market, but I'm skeptical.  I know the right answer depends partially on subjective factors (like risk-tolerance), but I thought I'd ask - what would you do?

I would appreciate any help fellow mustachians could offer!

[ncornilsen]

Did you factor in the return on investment you'd get by investing the ~137/month extra cashflow you'd get into an index fund?

[JohnGalt]

Your math looks right (can't really tell on your interest savings estimate from the data you provided) and I think you're making the right comparisons. 

One other thing to keep in mind is liquidity.  Stocks can be easily sold to get that cash back out.  Money paid towards principal to put you at 80% LTV probably can't be tapped even with a home equity loan. 

That said, I'd probably pay it down to dump PMI too. 

[Chiron]

Thanks for the replies.  Ncornilsen, you're right that I was not accounting for the opportunity cost of the 137/month.  Assuming this appreciates at 7% for 86 months, I will net another ~$1900, or ~$1520 after taxes.  This would push the necessary ROI for the alternative investment even higher, and further solidifies my view that I should pay down the mortgage.  My tax rate for calculating interest deductions is 28%.

I also value liquidity, but have enough other liquid assets that I would rather capture this guaranteed return right now.  Next question will be whether to refinance the mortgage once I get it below 80% LTV!.

Thanks for the help.