Author Topic: Mortgage Options (what makes more sense concerning future value)  (Read 4459 times)

tmterrill

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Basically I have the choice between pre-paid (by me) PMI and lender paid PMI.

The pre-paid pmi is $50 a month cheaper but I have to put down $6400 more at closing.

Taking into account the time value of money (future and present value) when will these two options break even using 4% return and 5% return?

I came up with about 15.5 years for 5%. Does this make sense or am I missing something?

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #1 on: March 03, 2015, 02:36:32 PM »
Strictly answering your question - I get about 15.5 as well.  In Excel: NPER(.05,-600,6400)

Of course with PMI, this isn't that complete of an analysis.  PMI is really expensive - how much more down would you need to avoid it entirely?  PMI is very expensive.

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #2 on: March 03, 2015, 02:39:35 PM »
[Edit - DanDarc's an idiot!]

Then thinking long term, PMI is like interest - that money is gone forever.

Higher down payment is more like paying extra principal - you get the benefit of that in the form of Home Equity.  Granted you have to sell the house or borrow against it to get use out of that, but the $6400 is not gone in the way the extra $50 / month for PMI would be.
« Last Edit: March 03, 2015, 03:53:36 PM by dandarc »

tmterrill

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #3 on: March 03, 2015, 02:59:15 PM »
There is no way we could come up with enough downpayment to reach 20 percent.

The PMI is very high at like 256 a month (co-borrower is under 720 score).

Pre-paid PMI rate is 4.25

Lender paid is 4.5

Regular pmi i 4 but obviously with 256 a month is pmi.

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #4 on: March 03, 2015, 03:02:39 PM »
I may have misunderstood what pre-paid PMI is - I thought it meant you needed a higher down-payment.  But do you mean you pay $6400 up front in exchange for $0 PMI for the rest of the loan?

tmterrill

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #5 on: March 03, 2015, 03:19:35 PM »
That is exactly correct.

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #6 on: March 03, 2015, 03:28:09 PM »
[editing - I fucked up the math in a big, big way here, leaving so others can see my stupidity]

Leaving this part to  - I am an idiot and misread OP multiple times, and this will show just how off I am on that.
So we're talking about a 960Kish mortgage, right?  Here's how I come up with that:

1.  Payment reduces by $50 / month by pre-paying PMI
2.  You save $256 / month on PMI by taking that option, but the interest is .25% higher
3.  So your principal and interest must have gone up by about $200 / month due to .25% increase in interest rate - nearly all of that due to interest
4.  2400 / .0025 = $960K

So here's how I'd look at this:

Option 1 - Regular PMI at 4%
Option 2 - Prepaid PMI - you pay $6400 up front, and you also pay .25% more over the life of the loan.

So Option 1 is $256 / month until your LTV is such that you can drop the PMI - $3072 / year
Option 2 is $6400 up front, plus the extra .25% interest - $2400 or so in the first year.  So you're paying $6400 to save $672 / year initially (the savings increase a bit each year), however once you reach the point where the PMI would go away any way, then you're paying that .25% extra for the life of the loan.

So, what I'd suggest - if you have the resources to do this, and the terms of the PMI don't prohibit this.  Take the 4% regular PMI loan, then pay the loan down as quickly as you can to get the PMI lifted - if you can do this in 5 years, you come out way ahead - even at 10 years.

This all assumes that my calculation of your loan amount is correct.
« Last Edit: March 03, 2015, 03:43:42 PM by dandarc »

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #7 on: March 03, 2015, 03:37:36 PM »
[more deeply flawed analysis here - leaving because I don't believe in deleting posts just because I made a mistake - this is so far off it needs to be identified as such though]

The lender paid option looks like the worst option to me - you save $6400 today, but you're paying another $200 / month so the break-even on that isn't even 3 years.

That makes sense too - they're fronting you $6400, obviously they want to make that up and then some to be willing to offer it.

Of course, if the plan is to hold the house for a few months only and rehab / flip it, then that changes everything - I've also been assuming you're planning on keeping this house for a long time.
« Last Edit: March 03, 2015, 03:52:48 PM by dandarc »

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #8 on: March 03, 2015, 03:41:20 PM »
Or I'm a moron - ignore everything I just said.

Way off on the value of the loan.

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #9 on: March 03, 2015, 03:50:40 PM »
So I was confused - loan must be more like 240K - $50 difference from original post X 12 / .0025 (saves a quarter % interest).

So the original question gets at the break-even on the Prepaid vs. Lender paid options - 15.5 years.

So if your plan is to have the loan outstanding for more than the 15.5 years (this is at the 5% discount rate) - then prepaying is the way to go.  Shorter than that, and your better off having the Lender pay it.

Probably worth it to analyze the regular PMI loan as well, but I don't want to make more of an ass of myself than I already have, so maybe when I'm lest tired I'll chime back in - maybe someone who is actually, you know, smart can chime in in the interim.

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #10 on: March 03, 2015, 04:11:14 PM »
So the scenario that I can think of where the regular loan might work out:

1.  You're staying in the house (and keeping the bulk of the loan) for a long time, so the decreased interest is a factor.

AND

2.  You can pay the loan down and get the PMI lifted very quickly - like 2.5 years or less quickly - costing ~$2400 / year  net to go this rout.  It would be like pre-paying the PMI, but spread out a bit, essentially.

So if either you're planning on leaving the house fairly early (in which case the lender paid option looks good), or it is unlikely you can pay the loan down fast enough (or the terms keep the PMI for longer than a couple years regardless), your original choice is the right one to look at.

darkcait

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #11 on: March 03, 2015, 04:19:09 PM »
I would go with the lender-paid PMI, and would not pay the $6400 upfront. The reason they want you to do this in exchange for a lower cost per month is that there are a lot of scenarios in which you will not pay the full PMI, like if you move out of your home, or make pre-payments which get you to 20% of the value before the predicted time. How much do you need to put down 20%? It will probably cost you a few hundred dollars eventually though to have the PMI removed, as they usually make you get another appraisal. I would take the lender paid option, pay your balance down as fast as possible, get another appraisal, and cancel PMI instead of handing over $6400.

tmterrill

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #12 on: March 03, 2015, 04:56:16 PM »
Purchase price is 364k with 5% down for reference. 

MLKnits

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #13 on: March 03, 2015, 04:59:47 PM »
There is no way we could come up with enough downpayment to reach 20 percent.

Have you considered the additional option of not buying more house than you need? If it's hard to come up with 20% ... you're going to be paying 100%, plus interest, over the life of the mortgage. What are rents like in the area?

tmterrill

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #14 on: March 04, 2015, 08:28:31 AM »
I live and work in Denver so....rents are very high and rising very quickly. Home prices are rising very quickly as well.

I understand home prices could take a dive again but it does not appear that will be anytime soon for the Denver area.

dandarc

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Re: Mortgage Options (what makes more sense concerning future value)
« Reply #15 on: March 04, 2015, 09:30:16 AM »
Alright - got a good night's sleep.  Here's is what we are missing:

Your payment is only going up about $50 however, the interest you pay is about $72 more in that first month.  So your additional cost is higher than was looked at yesterday in the form of your equity building more slowly.  Then the difference gets smaller each month from there.

Threw together a spread sheet which is attached comparing all 3 options.  Initially set to a 30 year loan, with monthly PMI for the whole 30 years.  The sheet computes PV of Interest + Monthly PMI at the specified discount rate, then keeps a running total - the Running total column that is green is your best choice at that particular month of the loan.

Looking at it this way, at that 5% discount rate, the break-even between pre-pay and lender paid is actually less than 10 years - month 116.  Interesting things happen depending on the length of the loan and the terms surrounding having PMI removed.

Ex: if this were a 15 year loan, and the PMI could be removed whenever you were scheduled to hit 78% LTV, the choice is actually between the lender paid and the regular monthly PMI.