Pay down mortgage to remove PMI vs Investing

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ExMachina
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Pay down mortgage to remove PMI vs Investing

Post by ExMachina »

Hello All,

I know the debate over paying off a mortgage vs investing in the stock market has been beaten to death here but I'd like some advice for a specific case. Last year my wife and I bought a home with a 5% downpayment. We were planning to wait another year or so until we could make a 20% downpayment without having to sell any stock but with interest rates so low at the time (2.5%) we decided to take the plunge. Of course, we now have a monthly PMI payment of around $142. If we let things run its course, we'll get rid of PMI after around 7 years and it will cost us around ~$13K in total. I am thinking that we should accelerate our mortgage payments so that we can get rid of PMI faster (realistically after about another year) which would save us ~$10K. Is this sound reasoning or should we just dump that money into the market? We max our retirement accounts and have investments in taxable accounts as well. The remaining amount we need to pay on the loan to get rid of PMI is ~50K.

Thoughts?
namajones
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Re: Pay down mortgage to remove PMI vs Investing

Post by namajones »

ExMachina wrote: Tue Sep 14, 2021 10:07 am Hello All,

I know the debate over paying off a mortgage vs investing in the stock market has been beaten to death here but I'd like some advice for a specific case. Last year my wife and I bought a home with a 5% downpayment. We were planning to wait another year or so until we could make a 20% downpayment without having to sell any stock but with interest rates so low at the time (2.5%) we decided to take the plunge. Of course, we now have a monthly PMI payment of around $142. If we let things run its course, we'll get rid of PMI after around 7 years and it will cost us around ~$13K in total. I am thinking that we should accelerate our mortgage payments so that we can get rid of PMI faster (realistically after about another year) which would save us ~$10K. Is this sound reasoning or should we just dump that money into the market? We max our retirement accounts and have investments in taxable accounts as well. The remaining amount we need to pay on the loan to get rid of PMI is ~50K.

Thoughts?
I would certainly take the sure gain (pay down PMI) vs. the hoped-for gain (stock market).
flyfishers83
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Re: Pay down mortgage to remove PMI vs Investing

Post by flyfishers83 »

You could also split the payment. Pay down your mortgage by x and put y into taxable. Say 1k per month extra towards your mortgage and the rest in taxable. With this approach, you're making some progress toward removing PMI. If your taxable account grows you can revisit making a significant payment. Model out a few different scenarios.

We did this last year, but we were also trying to balance student loan payoffs. We also just refinanced, with the refinance eliminating PMI.
hotscot
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Re: Pay down mortgage to remove PMI vs Investing

Post by hotscot »

You could lose in the market.
You will definitely gain by getting rid of PMI.

No brainer.
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hand
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Re: Pay down mortgage to remove PMI vs Investing

Post by hand »

Make sure you understand the exact mechanics and costs of removing PMI - in practice this can be more challenging (and costly) than simply achieving 20% equity. As you might imagine, lenders are loath to give up such a lucrative income stream and tend to make it difficult.
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Quirkz
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Re: Pay down mortgage to remove PMI vs Investing

Post by Quirkz »

hand wrote: Tue Sep 14, 2021 11:23 am Make sure you understand the exact mechanics and costs of removing PMI - in practice this can be more challenging (and costly) than simply achieving 20% equity. As you might imagine, lenders are loath to give up such a lucrative income stream and tend to make it difficult.
+1. The wording can be very specific. Mine *looked* like it would drop when I hit 20% equity, but what it really said is it would drop when the number of months had passed where the original amortization schedule was set to naturally hit that 20% level. No amount of down payment would help. (Or maybe I had to get to 25% instead of 20%, I forget.) I had to refinance after all to get rid of it. That said, each loan is different. Just make sure you read yours carefully.
absolute zero
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Re: Pay down mortgage to remove PMI vs Investing

Post by absolute zero »

I don’t think this is a no-brainer as some have suggested. You are effectively paying a rate of 3.4% on a $50k margin loan. That’s not great (your mortgage is 2.5% after all) but that’s not bad either, as I think current mortgage rates are actually closer to 3.4% than 2.5%. If you could continue to maintain your additional leverage at 3.4%, then I would say it makes sense for someone young like you to keep the PMI.
Edited after realizing that you need to add the 3.4% onto the 2.5%, to make an effective margin rate of 5.9%. This makes for a poor deal.
Last edited by absolute zero on Tue Sep 14, 2021 12:07 pm, edited 1 time in total.
Mike Scott
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Re: Pay down mortgage to remove PMI vs Investing

Post by Mike Scott »

Be sure of the specific terms of your mortgage to eliminate PMI. I would not pay off the mortgage in your case but IF you can save 10K in PMI by putting 50K toward your mortgage pay down... I would absolutely do this. 20% immediate return and then you can invest the PMI $ amount going forward to catch the market return.
gougou
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Re: Pay down mortgage to remove PMI vs Investing

Post by gougou »

$142 * 12 / $50K = 3.4%. Plus the 2.5% interest rate, you are basically paying 5.9% on a $50K loan which is probably not tax deductible. So you'll need to earn something like 8% pretax to be better off. I think you should pay the $50K off to get rid of the PMI.
Topic Author
ExMachina
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Re: Pay down mortgage to remove PMI vs Investing

Post by ExMachina »

flyfishers83 wrote: Tue Sep 14, 2021 11:19 am You could also split the payment. Pay down your mortgage by x and put y into taxable. Say 1k per month extra towards your mortgage and the rest in taxable. With this approach, you're making some progress toward removing PMI. If your taxable account grows you can revisit making a significant payment. Model out a few different scenarios.

We did this last year, but we were also trying to balance student loan payoffs. We also just refinanced, with the refinance eliminating PMI.
I like this idea. I'm currently already paying $500 extra toward principal monthly. If I were to do a 50/50 split, I could pay $2K extra toward principal and place 2K in the market.
Topic Author
ExMachina
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Re: Pay down mortgage to remove PMI vs Investing

Post by ExMachina »

hand wrote: Tue Sep 14, 2021 11:23 am Make sure you understand the exact mechanics and costs of removing PMI - in practice this can be more challenging (and costly) than simply achieving 20% equity. As you might imagine, lenders are loath to give up such a lucrative income stream and tend to make it difficult.
I'll definitely double check this. My loan is conventional (not FHA) and I believe the terms are that PMI is removed automatically when I get to 22% equity or I can contact the bank to have it removed when I get to 20%.
phinanciallyfit
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Re: Pay down mortgage to remove PMI vs Investing

Post by phinanciallyfit »

When did you get your mortgage? We bought in early 2018 and refinanced in Summer 2020. The increase in home value was enough to get rid of our PMI because our equity was now more than 20% of the home value. We did pay more than required to our mortgage, but the change in home value had a bigger impact. So you may want to consider refinancing if the home value has increased.
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ExMachina
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Re: Pay down mortgage to remove PMI vs Investing

Post by ExMachina »

absolute zero wrote: Tue Sep 14, 2021 11:43 am I don’t think this is a no-brainer as some have suggested. You are effectively paying a rate of 3.4% on a $50k margin loan. That’s not great (your mortgage is 2.5% after all) but that’s not bad either, as I think current mortgage rates are actually closer to 3.4% than 2.5%. If you could continue to maintain your additional leverage at 3.4%, then I would say it makes sense for someone young like you to keep the PMI.

The wrinkle here is that your “effective margin rate” (making that term up) due to PMI is going to steadily increase from this point onwards. So PMI will gradually become a worse and worse deal. One option to consider is keeping the PMI for a couple years, and then aggressively paying down your mortgage until you can remove PMI. A couple years from now, PMI won’t be such a great deal.

An important question is what is the AA of your investment portfolio? If you hold any bonds, then it doesn’t make much sense to keep the PMI in my opinion.

Almost 100% equities at this point. A mixture of FSKAX, ITOT, FZROX and AMZN. The only bonds I hold are part of a TDF I have in my 401k.
Last edited by ExMachina on Tue Sep 14, 2021 12:13 pm, edited 1 time in total.
Topic Author
ExMachina
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Re: Pay down mortgage to remove PMI vs Investing

Post by ExMachina »

phinanciallyfit wrote: Tue Sep 14, 2021 11:59 am When did you get your mortgage? We bought in early 2018 and refinanced in Summer 2020. The increase in home value was enough to get rid of our PMI because our equity was now more than 20% of the home value. We did pay more than required to our mortgage, but the change in home value had a bigger impact. So you may want to consider refinancing if the home value has increased.
Late 2020. The value of the home has definitely increased. I briefly considered refinancing but wasn't sure if the additional fees and hassle etc was worth it considering that I already have such a low interest rate.
hotscot
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Re: Pay down mortgage to remove PMI vs Investing

Post by hotscot »

absolute zero wrote: Tue Sep 14, 2021 11:43 am I don’t think this is a no-brainer as some have suggested.
The market doesn't guarantee anything.
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ExMachina
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Re: Pay down mortgage to remove PMI vs Investing

Post by ExMachina »

gougou wrote: Tue Sep 14, 2021 11:55 am $142 * 12 / $50K = 3.4%. Plus the 2.5% interest rate, you are basically paying 5.9% on a $50K loan which is probably not tax deductible. So you'll need to earn something like 8% pretax to be better off. I think you should pay the $50K off to get rid of the PMI.
Thanks for this. The math helps make the picture clearer for me.
absolute zero
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Re: Pay down mortgage to remove PMI vs Investing

Post by absolute zero »

hotscot wrote: Tue Sep 14, 2021 12:06 pm
absolute zero wrote: Tue Sep 14, 2021 11:43 am I don’t think this is a no-brainer as some have suggested.
The market doesn't guarantee anything.
I edited my post as I realized I made a math error. I agree that PMI is not a good deal for OP. But to your comment, I don’t think young investors should be searching for guarantees when they invest.
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hand
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Re: Pay down mortgage to remove PMI vs Investing

Post by hand »

ExMachina wrote: Tue Sep 14, 2021 11:57 am
hand wrote: Tue Sep 14, 2021 11:23 am Make sure you understand the exact mechanics and costs of removing PMI - in practice this can be more challenging (and costly) than simply achieving 20% equity. As you might imagine, lenders are loath to give up such a lucrative income stream and tend to make it difficult.
I'll definitely double check this. My loan is conventional (not FHA) and I believe the terms are that PMI is removed automatically when I get to 22% equity or I can contact the bank to have it removed when I get to 20%.
"Getting to 22%" is likely defined as making enough payments to get equity to 22% of original valuation.

Typically the process to have the PMI removed involves paying an above market rate for an appraisal of the bank's choosing to validate the 20% equity... Of course the bank and presumably the appraiser are highly motivated to keep the valuation low and keep PMI and there is no refund of your appraisal fee should the valuation insufficient.

I wouldn't be surprised if there are a number of unexpected delays (and perhaps lost paperwork) should the appraisal valuation be sufficient to remove PMI.

As a practical matter, refinancing may be a better path forward - given the current low rates, frothy housing values and permissive lending environment, your time may be better spent looking for a lender who will refinance your current loan without PMI based on an appraisal waiver (value your house based on their computer model).
shess
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Re: Pay down mortgage to remove PMI vs Investing

Post by shess »

ExMachina wrote: Tue Sep 14, 2021 12:05 pm
phinanciallyfit wrote: Tue Sep 14, 2021 11:59 am When did you get your mortgage? We bought in early 2018 and refinanced in Summer 2020. The increase in home value was enough to get rid of our PMI because our equity was now more than 20% of the home value. We did pay more than required to our mortgage, but the change in home value had a bigger impact. So you may want to consider refinancing if the home value has increased.
Late 2020. The value of the home has definitely increased. I briefly considered refinancing but wasn't sure if the additional fees and hassle etc was worth it considering that I already have such a low interest rate.
I realize the mortgage system has changed a lot in the past 20 years, but ... 20 years back, we bought a house with an 80% LTV mortgage (so no PMI) plus a 15% second. The blended rate was approximately the same as what we'd have paid in PMI, but we had the choice of paying down or paying off the second independently of the first. I liked having the flexibility, but in the event prices rose and rates fell so within a year we refinanced into a single mortgage which was under 80% LTV. Back in those days lenders were throwing zero-cost refinances at everyone, so you'd probably have a bit of a different evaluation today.

Personally, I'd have zero compunctions about putting up $50k to get rid of PMI. I'd also be willing to refinance to do it, or, more likely, bring $25k to a refinance to do it. I have an irrational distaste for things like PMI, and not seeing that line item on my mortgage statement every month would be a quality-of-life improvement. Additionally, right now today I'd be more nervous about putting $25k or $50k into the market than into my mortgage. But it's probably harder to make the argument in strictly financial "expected returns" type terms.
JayDee37
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Re: Pay down mortgage to remove PMI vs Investing

Post by JayDee37 »

Another vote for getting rid of the PMI as soon as you can.
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dbforbes
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Re: Pay down mortgage to remove PMI vs Investing

Post by dbforbes »

Having experienced PMI and how wonderful it is paying off enough to refinance and drop it, I would go with dropping the PMI every time. Best of luck!
chet96
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Re: Pay down mortgage to remove PMI vs Investing

Post by chet96 »

Check your loan terms - usually you have to pay at least 2-3 years of PMI and pay down to 80% according to the original amortization schedule. As a added kick, then pay the bank to do an appraisal to prove you have 20% equity. (It's not as simple as requesting an appraisal and showing you have 20% equity - they look at the original schedule as the trigger). Paying to 78% allows automatic termination. (Somehow my bank tacked on an extra month - their explanation did not make sense - basically because they can).

I'm getting irritated just thinking about it. Check out the mega refinance thread, and find a $0 refinance - assuming you have the equity in the house that is.
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grabiner
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Re: Pay down mortgage to remove PMI vs Investing

Post by grabiner »

ExMachina wrote: Tue Sep 14, 2021 10:07 am If we let things run its course, we'll get rid of PMI after around 7 years and it will cost us around ~$13K in total. I am thinking that we should accelerate our mortgage payments so that we can get rid of PMI faster (realistically after about another year) which would save us ~$10K. Is this sound reasoning or should we just dump that money into the market? We max our retirement accounts and have investments in taxable accounts as well. The remaining amount we need to pay on the loan to get rid of PMI is ~50K.
If the math works out this way, then paying $50K on the loan next year eliminates $10K of PMI over five years. This $10K has a duration of 2.5 years (since it is the same dollar amount every month for five years), so this is $4K per year, an effective return of 8% above the loan rate for the first five years.

So, if you could make an investment which earned 10.5% for five years, then 2.5% after that until you sell the house or refinance, would you make it? This is a much better deal than the usual loan paydown.

(And you retain other options as well. For example, after you have paid down the loan, you might choose to refinance to a 15-year term with similar payments at an even lower interest rate, rather than retaining the original loan which now has 23 years left.)
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