Author Topic: Eliminate which first - PMI or Student Loans?  (Read 5156 times)

Adventure

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Eliminate which first - PMI or Student Loans?
« on: April 16, 2013, 02:56:13 PM »
Is my current approach efficient?

I would appreciate some input. My wife and I may have made some less-than-mustachian choices in the past, but we have never had credit card debt. We are currently paying down the mortgage to obtain 22% equity in order to eliminate the mortgage insurance. We plan to then use the extra funds to pay off the student loans, or at least the higher interest ones. Then we can invest the surplus cash in a rental house or stocks or whatever makes sense by that time. Here are the details:

We just refinanced to a $318,000 mortgage @ 3.25%, 30 yrs. Home value is $340,000 according to assessment when purchased. I have read that our streamline FHA refi means the home value is still valid as PMI assessment.

The student loans break down like this:
$4,000 @ 6.8%;
$14,000 @ 3.5%;
$350 @ 2.39%;
7,000 @ 1.62%.

If I left out some data needed, please ask. I am relatively new to loans, finance etc. If something doesn't make sense please let me know because I could use a sanity check here. Is (PMI -> student loans -> investments) the right order? Thanks in advance for any help or advice!

JohnGalt

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Re: Eliminate which first - PMI or Student Loans?
« Reply #1 on: April 16, 2013, 03:11:58 PM »
Is my current approach efficient?

I would appreciate some input. My wife and I may have made some less-than-mustachian choices in the past, but we have never had credit card debt. We are currently paying down the mortgage to obtain 22% equity in order to eliminate the mortgage insurance. We plan to then use the extra funds to pay off the student loans, or at least the higher interest ones. Then we can invest the surplus cash in a rental house or stocks or whatever makes sense by that time. Here are the details:

We just refinanced to a $318,000 mortgage @ 3.25%, 30 yrs. Home value is $340,000 according to assessment when purchased. I have read that our streamline FHA refi means the home value is still valid as PMI assessment.

The student loans break down like this:
$4,000 @ 6.8%;
$14,000 @ 3.5%;
$350 @ 2.39%;
7,000 @ 1.62%.

If I left out some data needed, please ask. I am relatively new to loans, finance etc. If something doesn't make sense please let me know because I could use a sanity check here. Is (PMI -> student loans -> investments) the right order? Thanks in advance for any help or advice!

How much is the PMI?  It looks like it will take you ~$50,000 in additional home equity to drop it.  If PMI is $100/mo (made up number) then your return on putting an immediate $50,000 towards the mortgage would be (for the first few years at least) $1200/$50,000 + $50,000*.0325 - whatever amount you'll no longer be able to deduct from taxes for not paying PMI and mortgage.

My guess is that the math will tell you that paying off the 6.8% loan should come first, it's probably somewhere around a wash to slightly in favor of PMI against the 3.5%, and you should just hang onto the other two student loans paying the minimum.  In the grand scheme of things - the $$ amounts are probably small enough that you should just go with whichever makes you more comfortable.  Some people would rather pay off the smallest balances first so they have fewer bills to pay, some want to maximize efficiency by holding onto cheap debt and investing, others fall somewhere in between.  The key is to stick to using that money to increase your networth (either through investments or debt repayment) rather than spending it on stuff or using it to decrease your networth by taking on bad consumer debt (credit cards, car payments, etc). 

Another Reader

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Re: Eliminate which first - PMI or Student Loans?
« Reply #2 on: April 16, 2013, 03:19:51 PM »
I would convert the extra MI payment to an effective total payment and then calculate the effective interest rate.  Likely it makes sense to pay off at least the high interest rate student loan first versus a 3.25 percent interest rate loan even with MI.  Also, the new FHA loans have MI for the life of the loan.  In your shoes, I would verify that the MI can be cancelled. 

However, what I would do would depend on the stability of my employment and any anticipated changes in income.  Because of their treatment in bankruptcy, I'm generally in favor of paying off student loans ASAP.  And kick that $350 loan to the curb this afternoon.  That's just silly to have on the books.

Adventure

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Re: Eliminate which first - PMI or Student Loans?
« Reply #3 on: April 16, 2013, 03:29:01 PM »
Thanks for the fast response! The PMI is $315 per month. Taxes $230, Hazard Insurance $50, all in addition to the min payment of $1380 which comes to just under $2000/month.

Adventure

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Re: Eliminate which first - PMI or Student Loans?
« Reply #4 on: April 16, 2013, 03:44:08 PM »
How much is the PMI?  It looks like it will take you ~$50,000 in additional home equity to drop it.  If PMI is $100/mo (made up number) then your return on putting an immediate $50,000 towards the mortgage would be (for the first few years at least) $1200/$50,000 + $50,000*.0325 - whatever amount you'll no longer be able to deduct from taxes for not paying PMI and mortgage.

Using your math the PMI roughly (without looking into taxes) indicates somewhere near 10%, but I'm not sure how far lower exactly.

Also, I don't have $50,000, so this will be a gradual payoff from this point forward. The PMI obviously does not diminish over time until it vanishes, while the paying off the student loans will result in less interest paid in the meantime, while we gradually pay it off. I'm not sure I communicated that clearly...

We did put an extra $15,000 towards the mortgage last month (I didn't want to complicate the original post) but we don't want our emergency fund any lower than it is now. $2200/month equates to, I think, 45 more payments, though we'll most likely find more money in the meantime and do better than that.

RewardTraveler

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Re: Eliminate which first - PMI or Student Loans?
« Reply #5 on: April 17, 2013, 08:45:33 AM »
Also, I don't have $50,000, so this will be a gradual payoff from this point forward. The PMI obviously does not diminish over time until it vanishes, while the paying off the student loans will result in less interest paid in the meantime, while we gradually pay it off. I'm not sure I communicated that clearly...

We did put an extra $15,000 towards the mortgage last month (I didn't want to complicate the original post) but we don't want our emergency fund any lower than it is now. $2200/month equates to, I think, 45 more payments, though we'll most likely find more money in the meantime and do better than that.

I'm assuming the $15k has been included in the $318k remaining balance, right?

How long will it take before you can get below the PMI level?  Is that the 45 month timeline?  As you noted, you won't see the return on eliminating PMI until you actually get below 80%.  On the positive side, though, most of your loan debt is close to or below your mortgage interest rate so even if you're not getting a PMI benefit, you're not really worse off for paying it down.

What I would suggest is modeling out your cash flows for the next few years to see which scenario will result in the least interest/PMI possible.  It will depend on how quickly you're able to accumulate additional savings, but if I had to guess, the best mathematical answer will likely be to pay off your student loan at 6% first then focus on building enough equity to eliminate PMI and finally eliminate the remaining loans after PMI is gone.