Mortgage Reduction vs Investment Opportunity

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grokzilla
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Joined: Tue Aug 16, 2011 8:25 am

Mortgage Reduction vs Investment Opportunity

Post by grokzilla »

Howdy:

I've been a forum lurker and investment-style follower for a number of years now, but suddenly I find myself with a financial question (part finance, part investment) I hoped someone might be able to help me with -- hence my first post!

Anyway, my financial conundrum seems simple, but I'm struggling with picking out the best path. We refinanced our home loan not too long ago and have been enjoying a nice reduction in payments, but in the process picked up PMI on the mortgage. The PMI is relatively high as well at $250/month and $3,000/year, but the overall loan savings still made the refinance make complete sense.

Obviously, we're interested in removing the PMI as soon as possible, but that seems to require a Loan to Value of 79% to accomplish, which is a notable sum in our case -- approximately $40,000. Doing the basic math that seems to net out at taking 13 years to pay itself back, which seems a not very effective use of that $40K -- but I'm not entirely convinced of that.

Obviously, we'd be saving $3K per year and that $40K wouldn't be gone but would be stuck in a relatively illiquid asset and certainly not growing in value anytime soon. So, we'd have some opportunity cost on that I guess...just not sure what that amount is or how to express it. Currently, it's just sitting in a MM account earning a paltry 1+%, but it's not emergency money and could certainly go into the market to generate better returns.

Anyway, we do have the funds available to do it. It would not derail any retirement investments or planning to do so, we're both working, 2 pre-college kids, just turned 40 and we've been in the home for 6 years now (no real idea how much longer we plan to stay, but we have no plans to leave either).

So, my basic Qs:
1) Is removing the $3k/year PMI the best course, even though we "lose" the $40K?
2) Would it be better to invest that $40K for a better return and continue paying the PMI?
3) Is there something else here I'm not considering?

Really appreciate any suggestions or thoughts you can provide!

Brandon
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kenyan
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Post by kenyan »

Since you don't need the $40K elsewhere -

You're not just saving $3,000 per year; you're also saving interest on that principal balance. $40K at 4.5% is another $1800 per year. Some of that will come out of your tax deduction, but nevertheless it's more money saved. If you get a total benefit of $4500 risk-free saved in one year on $40,000, I'd say that's pretty darn good. Read: $4500/40000 = 11.25%. Even though a house is not risk-free, lowering your payments is more or less a risk-free investment. You won't get anywhere near those returns in any comparable investment.
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kenyan
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Post by kenyan »

http://www.bogleheads.org/wiki/Paying_d ... _investing

No specific mention of PMI; you'll have to take that into consideration.
sjb19
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Post by sjb19 »

Assuming you really don't need the $40k for anything else (and won't for the next few years), I would agree with kenyan and ditch the PMI.

It may seem odd, but another option might be to refi again. Rates are probably a bit lower unless you closed in the last month or so and you might luck out and get a higher appraisal, meaning less of the $40k would have to be rolled into the new loan to avoid PMI.
ResNullius
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Post by ResNullius »

Get out of debt as soon as you reasonably can. Then save and invest prudently for an uncertain future.
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Abe
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Post by Abe »

I agree with all the above post. To stop money going out is the same as receiving money in. Actually better because you are not paying taxes on it.
Assuming you are planning on staying in the house a long time, I would do it.
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G-Money
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Post by G-Money »

Think of it this way: holding onto that $40,000 is costing you more than 7.5% annually.

Paying down principal by $40,000 completely eliminates your $250/month PMI. If you purchased a bond for $40,000 that paid you $250/month, its yield would be 7.5%. Hard to beat that risk-free in this environment.

But it's actually better than that. Paying down your mortgage principal reduces the amount of interest that accrues. So, for the sake of argument, assuming you refi'd to 4.5% for 30 years, the yield on your investment of $40,000 would actually be 7.5% + 4.5% = 12% annually, risk-free. For "risk-free" comparisons, a 10-year Treasury is yielding ~2.3%, while the 30-year is yielding ~3.7%. Bernie Madoff was only offering 10% returns.

So, assuming you have no near-term liquidity issues, I would instantly use the $40,000 to pay down the principal.
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DiscoBunny1979
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Post by DiscoBunny1979 »

Well, if you refinance to a 15 year fixed at about 4% using that $40,000 to avoid PMI with a resulting mortgage of about $160,000 you're payments will be about $1183 a month. What's your current monthly payment without taxes/insurance?
HornedToad
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Post by HornedToad »

Depending on when you refinanced, you typically have PMI for a minimum of 2 years. So to get rid of it you might have to refinance again.

I agree with those saying to get rid of PMI. It's one thing to invest in market vs. pay down a mortgage, but PMI is super expensive.
Sulvar
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Post by Sulvar »

Before you do this, make sure that you can actually get the PMI removed if you pay down the loan to value. There are usually a number of steps required to remove PMI and they will differ from bank to bank. An appraisal is usually involved (at your cost) and if the appraisal doesn't come in right you can be stuck with PMI. In my case with Bank of America, I had to have LTV of less than 80% AND the new appraisal couldn't be less than the purchase price of the home.

Given all of this, it might be better to just re-finance.
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touchdowntodd
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Post by touchdowntodd »

also look for minimal time frames to have PMI, many loans are locked in for 2-5 years..

refi would be my move .. 15yr FHA has a higher LTV where PMI is needed, so you may not need to use the whole $40k ..

ps - grok? are you on marks daily apple as well as here? pm me if so! PRIMAL RULES!
tryin to do this right... thanks guys
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