Author Topic: Eliminate PMI with 20% Down or Invest (First Time Buyer)  (Read 2641 times)

drtownhouse

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Eliminate PMI with 20% Down or Invest (First Time Buyer)
« on: March 27, 2014, 06:56:11 PM »
I am a first time home buyer closing on a townhouse in about 3 months. I am having difficulty understanding how to correctly calculate whether it is more "profitable" to eliminate the PMI on my new home by putting 20% down, or to use the excess funds for investing. I found an interesting discussion about this issue here: http://www.mrmoneymustache.com/forum/ask-a-mustachian/pmi-payoff-roi/

However, the OP already owned the house, so it appears the calculations might be different than for the person who hasn't yet closed. I also didn't notice a definitive answer as to how to make these calculations.

Background Info
Sales Price: $258,995
Loan Type: Fixed 30-year loan
Mortgage rate with 10% down payment: 4.625%
Mortgage rate with 5% down payment: 4.7%
Monthly PMI: $182.48

I'm not sure how to compare paying off the PMI versus investing. Could I assume I intend to put down 10% and therefore would have $25,899.50 left over for investing if I didn't put 20% down? 

One problem is I do not know how to determine which percentage of monthly payments goes toward principal and interest. I suppose once I know this I could determine how long it would take to eliminate PMI if I invested the extra $25,899.50 rather than using it to eliminate PMI.

To compare the options I imagine doing something like this:

Option 1 (investing): (Total gains from investment over period it takes to eliminate PMI) - (PMI Payments over that period + the mortgage interest paid on $25,899.50)

Option 2 (Put 20% down): Profits = Avoided PMI payments over the PMI period + the mortgage interest payments saved

My apologies if this is totally off! Thank you.

bikebum

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Re: Eliminate PMI with 20% Down or Invest (First Time Buyer)
« Reply #1 on: March 27, 2014, 07:02:10 PM »
One problem is I do not know how to determine which percentage of monthly payments goes toward principal and interest.

Try this: http://www.myamortizationchart.com/

In the beginning, a higher percentage goes towards interest. This percentage decreases as you pay off the loan.

drtownhouse

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Re: Eliminate PMI with 20% Down or Invest (First Time Buyer)
« Reply #2 on: March 27, 2014, 07:22:08 PM »
One problem is I do not know how to determine which percentage of monthly payments goes toward principal and interest.

Try this: http://www.myamortizationchart.com/

In the beginning, a higher percentage goes towards interest. This percentage decreases as you pay off the loan.

Awesome. Thank you!

bikebum

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Re: Eliminate PMI with 20% Down or Invest (First Time Buyer)
« Reply #3 on: March 27, 2014, 07:25:26 PM »
Here's a simple way to look at it:

PMI costs $2,189.76 per year, which is 8.45% of the money you save by putting 10% down rather than 20% ($25,899.50). So you are borrowing money from the mortgage already, and then paying another 8.45% to borrow more than 80% of the home value.

Would you take out a loan at 13.075% (8.45% + 4.625%) to invest? I would not.

Is PMI the same whether you put down 5% or 10%? If so, then paying PMI and putting down 5% is like borrowing $38,849.50 at 10.34% (5.64%+4.7%). I wouldn't do that either. There is no guarantee that you will get certain returns in the market, but putting down 20% does guarantee that you will save by not paying PMI.

Some other things to think about: I was told that if you do PMI you have to pay it for at least 5 years, even if you get to 20% equity before then. When you look at the amortization calculator you'll see that it can take a long time to pay down the principal, as early on most of the payment goes to interest.

I changed the numbers because I forgot to add the mortgage rate the first time.
« Last Edit: March 27, 2014, 07:45:55 PM by bikebum »

EscapeVelocity2020

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Re: Eliminate PMI with 20% Down or Invest (First Time Buyer)
« Reply #4 on: March 27, 2014, 08:56:49 PM »
PMI is expressly set up for 'risky home buyers', therefore you should never pay for it if you are 'Mustachian'.  This is one of the few times that I would take the Market at its word, take on a home loan at the prevailing rate, but pay the 20% down as required to qualify as a 'reasonable risk'.  If you are willing to take on more leverage, you are veering off into the deep waters that only the very sophisticated (or lucky) have navigated successfully.  Up to you, but I'd prefer to go to Vegas if I knowingly take on risk.