Pay off PMI or Student Loans

[LearningMustachian72]

Hey!

(A) Student Loans - I have $18,500 in student loans at 4% variable interest and am currently paying $573 per month.  Due to tax strategies for another purpose, I cannot deduct interest paid on student loans.

(B) PMI - I have a home loan of $321,000 with a fixed interest rate of 3.5% and PMI of $120 per month.  I am currently making payments of $2,214.  My equity will reach 20% and PMI will drop when I pay an additional $58,640 towards the principal. 

I have roughly $2,500 a month to put towards either.  Which should I pay down first?

Thank you in advance!

[MrUpwardlyMobile]

the student loan.  That rate is increasing over time. The faster you pay, the more you save.  The $2500 is not going to make as big a dent on the mortgage issue as it will on the loan.  The second you kill that student loan, you have $573.00 more per month to throw at the mortgage.


You can remove half a year of payments from the student loan and you have only 3 years left as it is.  Since it would take much longer to reach the mortgage number, I think it’s a mathematically sound position.  Once you pay off the student loan, you’ll pay that $2500 extra toward the mortgage balance in less than 5 months with the freed up cash flow.  No doubt in my mind you’ll be more comfortable with this.

[thd7t]

PMI.  PMI is like an additional interest rate on top of a portion of your mortgage, so you're paying 3.5% + 2.5% in PMI (on $58k), this year.  However, PMI doesn't decrease with principal (doesn't amortize), so each year your effective interest rate goes up on that portion of your loan.  I have a bunch of threads where I've averaged out the interest rate of PMI over the portion of the loan that it's applied to and it's never been under 10%.  PMI is a hair-on-fire situation.

If you want, I can do the math on your situation, but it's going to be a really high rate.

[NoStacheOhio]

the student loan.  That rate is increasing over time. The faster you pay, the more you save.  The $2500 is not going to make as big a dent on the mortgage issue as it will on the loan.  The second you kill that student loan, you have $573.00 more per month to throw at the mortgage.


You can remove half a year of payments from the student loan and you have only 3 years left as it is.  Since it would take much longer to reach the mortgage number, I think it’s a mathematically sound position.  Once you pay off the student loan, you’ll pay that $2500 extra toward the mortgage balance in less than 5 months with the freed up cash flow.  No doubt in my mind you’ll be more comfortable with this.

Student loan first. In both cases, you're clearing the debt around August 2019, but paying the SL first knocks it out November 2018 (vs. PMI in May 2019 and SL in August 2019 in the PMI-prioritized paydown).

[Lady SA]

I would suggest splitting down the middle: put $1500 towards PMI and an extra $1k toward the SL. That may not be entirely mathematically optimal, but might work well if you want to hedge your bets a bit.

Personally, I also have a variable interest rate loan, but the balance is only $9k. I have plenty in savings to pay it off completely if the rate rises to 5%, but otherwise I route all of my cash flow to other priorities and am just paying the minimums while it is under 4%. If I did pay it off in one swoop, it would put a dent in our beater-car replacement fund, but that would be replenished soon enough. That savings account is my safety net when (not if) rates rise, but I'm taking advantage of my temporarily low rate to focus on other things.

However, $18k is quite a chunk of change to be nervous about the rate rising, and would take a huge chunk out of any cash savings you had to clear it out, so I would want to bring the principle down to where your cushion could absorb it if necessary.

[LearningMustachian72]

Thank you for all the replies everyone!

The variable interest rate does scare me and I like the idea of completely clearing my student loans.  I am leaning that direction unless anyone can convince me otherwise.

Thanks again, truly appreciate all of the responses.

[thd7t]

So, because you didn't give too much information on your loan situation, I'm going to make a few guesses.
1) It's a new loan based on a $330k purchase price with $9k down ($321k remaining)
2) $58k payments before PMI is complete.
3) $1442 P&I payment.
4) $120/month PMI.

Now, you effectively have two loans.  One is for $263k at 3.5% interest.  The other is for $58k at 3.5% interest + $1440/year.  At this rate, you'll be paying PMI for 8.5 years.  Your interest on the $58k alone in that period is $9,100.  Your PMI is $12,240.

This means that your total payments over 8.5 years on only the top $58k of your loan are $21,340.  Amortized over the period where you're paying PMI, this is an average interest rate of 7.75%.

Comparing this to the student loan, are you confident that your average interest rate will be 8% or higher over the same amount of time?  It doesn't sound like a good bet to me.

[LearningMustachian72]

@thd7t thank you for breaking it down this way, much appreciated!  This is what I was looking for...appears the wise move is to keep making my minimum $575 on the student loans and putting any additional funds towards my mortgage.

[MrUpwardlyMobile]

So, because you didn't give too much information on your loan situation, I'm going to make a few guesses.
1) It's a new loan based on a $330k purchase price with $9k down ($321k remaining)
2) $58k payments before PMI is complete.
3) $1442 P&I payment.
4) $120/month PMI.

Now, you effectively have two loans.  One is for $263k at 3.5% interest.  The other is for $58k at 3.5% interest + $1440/year.  At this rate, you'll be paying PMI for 8.5 years.  Your interest on the $58k alone in that period is $9,100.  Your PMI is $12,240.

This means that your total payments over 8.5 years on only the top $58k of your loan are $21,340.  Amortized over the period where you're paying PMI, this is an average interest rate of 7.75%.

Comparing this to the student loan, are you confident that your average interest rate will be 8% or higher over the same amount of time?  It doesn't sound like a good bet to me.

I’m pretty sure this math doesn’t hold water because the PMI isn’t not equivalent to interest. It doesn’t drop progressively over time.  There is no savings until that principal threshold is reached.  In other words, he sees no benefit on that if he pays 2500 now or in 31months, which is when he’d have more than 2500 in cash flow free from paying down the student loan.

[Catbert]

I can only add, make sure you understand how your PMI (or other mortgage insurance) works.  From what I've heard (never paid PMI myself) the rules have changed over the years.   Is it getting to 80% of current value or purchase price?  Can it be paid off early? (I vaguely remember proposals of making it a flat dollar amount, period.)  Not asking for answers, just suggesting you ensure you know how your loan operates.

Also consider how quicking houses in your area are appreciating.  If you're in a hot area with values going up quickly you make get to 80% more quickly than you think.

[thd7t]

So, because you didn't give too much information on your loan situation, I'm going to make a few guesses.
1) It's a new loan based on a $330k purchase price with $9k down ($321k remaining)
2) $58k payments before PMI is complete.
3) $1442 P&I payment.
4) $120/month PMI.

Now, you effectively have two loans.  One is for $263k at 3.5% interest.  The other is for $58k at 3.5% interest + $1440/year.  At this rate, you'll be paying PMI for 8.5 years.  Your interest on the $58k alone in that period is $9,100.  Your PMI is $12,240.

This means that your total payments over 8.5 years on only the top $58k of your loan are $21,340.  Amortized over the period where you're paying PMI, this is an average interest rate of 7.75%.

Comparing this to the student loan, are you confident that your average interest rate will be 8% or higher over the same amount of time?  It doesn't sound like a good bet to me.

I’m pretty sure this math doesn’t hold water because the PMI isn’t not equivalent to interest. It doesn’t drop progressively over time.  There is no savings until that principal threshold is reached.  In other words, he sees no benefit on that if he pays 2500 now or in 31months, which is when he’d have more than 2500 in cash flow free from paying down the student loan.

He doesn't see cash flow, but he does see a real dollar drop in payment that sees no principal reduction.  Because PMI doesn't progressively decrease, its effective rate increases.  In addition, it's not paid on the cost of the whole loan, only on the top 20%. 

[thd7t]

I can only add, make sure you understand how your PMI (or other mortgage insurance) works.  From what I've heard (never paid PMI myself) the rules have changed over the years.   Is it getting to 80% of current value or purchase price?  Can it be paid off early? (I vaguely remember proposals of making it a flat dollar amount, period.)  Not asking for answers, just suggesting you ensure you know how your loan operates.

Also consider how quicking houses in your area are appreciating.  If you're in a hot area with values going up quickly you make get to 80% more quickly than you think.

This is an excellent point.  If you have a newer FHA loan, for instance, MIP is for the life of the loan.  This has all changed since I last dealt with it, personally.

[frugaliknowit]

"I have roughly $2,500 a month to put towards either.  Which should I pay down first?"

Is this $2500 extra (on top of the minimum payment or what you are paying now)?  If so, I am inclined to say the mortgage.  $58,640/2500 = 23.465.  You can be DONE with this in two years (asssuming your home stays the same value or goes up).  I doubt the SL can catch up in interest rate with the combination of the mortgage + PMI effective interest rate after tax. 

[LearningMustachian72]

Yes, the $2,500 is on top of the monthly student loan and mortgage payments.  Thank you for the input!

[charis]

I can only add, make sure you understand how your PMI (or other mortgage insurance) works.  From what I've heard (never paid PMI myself) the rules have changed over the years.   Is it getting to 80% of current value or purchase price?  Can it be paid off early? (I vaguely remember proposals of making it a flat dollar amount, period.)  Not asking for answers, just suggesting you ensure you know how your loan operates.

Also consider how quicking houses in your area are appreciating.  If you're in a hot area with values going up quickly you make get to 80% more quickly than you think.

This is an excellent point.  If you have a newer FHA loan, for instance, MIP is for the life of the loan.  This has all changed since I last dealt with it, personally.

True on FHA loans.  We paid PMI as scheduled until we reached 80% and then refinanced into a conventional loan with no PMI.

[MrUpwardlyMobile]

Yes, the $2,500 is on top of the monthly student loan and mortgage payments.  Thank you for the input!

So you could pay off the student loan in ~6 months...  and then be paying 3k per month more at the mortgage balance....

[MrThatsDifferent]

Yes, the $2,500 is on top of the monthly student loan and mortgage payments.  Thank you for the input!

So you could pay off the student loan in ~6 months...  and then be paying 3k per month more at the mortgage balance....

Yeah, weird, this was my thinking. Get the SL done as soon as possible in 6 months, then throw everything at the extra needed to get rid of the PMI in around 18 months. In 2 years, you’ll have both of these gone and can re-finance your loan and get better terms. Good luck!

[thd7t]

Yes, the $2,500 is on top of the monthly student loan and mortgage payments.  Thank you for the input!

So you could pay off the student loan in ~6 months...  and then be paying 3k per month more at the mortgage balance....

That does work, but it is less efficient.  It's more of a Dave Ramsey approach.