Choosing between eliminating PMI or investing

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SnowNovel
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Joined: Tue Dec 01, 2015 12:36 pm

Choosing between eliminating PMI or investing

Post by SnowNovel » Fri Feb 01, 2019 4:49 pm

I have a pile of money I could use to pay down my mortgage and eliminate PMI. Alternatively, I could just invest the money. I'm trying to understand how to choose between the two options.

If the mortgage did not involve PMI, it would be a pretty straightforward decision. Do I bet that my investments will return a higher interest rate than that of the mortgage? If so, then invest. Otherwise pay down the mortgage.

With PMI, I don't understand how to perform this calculation. Once PMI is eliminated, suppose that I will pay that amount extra into my investments. That impacts my investment gains. But I'll also pay less interest on the mortgage. How do I run a calculation around those factors?

As an extra bonus wrinkle, I could also re-cast my mortgage for a $250 fee after the pay down, freeing up even more money per month for investing.

Some real numbers to play with, if that helps.

Home value: $418,000
Original maturity date: 12/01/2047
Mortgage rate: 3.875%
Monthly payment: $2,097
Loan principal: $356,366
Monthly PMI: $121.82
PMI eliminated on request at principal: $334,400
Principal payment required to request PMI cancellation: $21,966

How do I calculate the "break even" percent at which it makes sense to invest the pile of money rather than paying down the mortgage? Does it make a difference if I expect to be in my house only 10 more years versus being in my house for 30 more years? Does it make a difference if I re-cast?

mighty72
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Re: Choosing between eliminating PMI or investing

Post by mighty72 » Fri Feb 01, 2019 4:59 pm

121*12~1440
1440/21000~7%
7+3.875% = 10.875
It is a 10.875% guaranteed rate of return if you get rid of PMI + interest saved

This is crude math and others are free to poke holes in it. There might be tax advantages of not paying do.

But to me, getting rid of PMI is no brainier.
Last edited by mighty72 on Fri Feb 01, 2019 6:29 pm, edited 1 time in total.

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8foot7
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Re: Choosing between eliminating PMI or investing

Post by 8foot7 » Fri Feb 01, 2019 5:00 pm

Not even a question, PMI. You're paying $122 post tax per month for an insurance policy that will benefit someone else if you lose your home. There is no sense in spending $1,464 a year on that if you have the means to get rid of it.

Quirkz
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Re: Choosing between eliminating PMI or investing

Post by Quirkz » Fri Feb 01, 2019 5:03 pm

My first question is, are you sure they'll drop the PMI when you hit that dollar value? I ran around in circles with a lender before I finally caught on to subtle meanings of the wording - in my case, it wasn't at the dollar value, it was at the date that the loan, *if paid off normally*, was scheduled to hit that dollar value. Yours may be worded differently than mine, but I find it's a common misunderstanding about PMI, so it's worthwhile to make sure the lump sun will do you good before applying it. I had to refinance to get out of mine.

I'll mostly abstain from the other parts, because I don't know how to calculate it. For me, the PMI is definitely wasted money, and the mortgage interest is a sure cost. Investment is an unsure thing (you can guess and average but it's still speculative). I don't know how to compare the two in a reasonable fashion. Maybe you could look at is as how good would your investment have to be to make up for $120/month in PMI costs?

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Wiggums
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Re: Choosing between eliminating PMI or investing

Post by Wiggums » Sat Feb 02, 2019 8:54 am

I would eliminate the PMI...

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stilts1007
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Re: Choosing between eliminating PMI or investing

Post by stilts1007 » Sat Feb 02, 2019 9:20 am

We were in a similar situation 5 or 6 years ago & wanted to pay a big lump sum to get rid of our PMI; as Quirkz said, they probably won't automatically eliminate it just because you get to the 20% equity point or whatever the break point is.
We ended up refinancing to a lower rate & shorter term and that lump sum money went into the pot as part of the transaction which got rid of the PMI. Otherwise the PMI wouldn't have gone away until we got to the date where the PMI would've normally expired with normal monthly payments.

ETadvisor
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Re: Choosing between eliminating PMI or investing

Post by ETadvisor » Sat Feb 02, 2019 9:36 am

Eliminate PMI yesterday :twisted: It is insurance for the lender that provides you zero benefit and does not build equity in your home.
Last edited by ETadvisor on Sat Feb 02, 2019 10:05 am, edited 1 time in total.

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Nate79
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Re: Choosing between eliminating PMI or investing

Post by Nate79 » Sat Feb 02, 2019 10:03 am

I agree with the others that if you can get rid of PMI it is a no brainer. But make sure know the exact rules to do so.

Admiral
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Re: Choosing between eliminating PMI or investing

Post by Admiral » Sat Feb 02, 2019 3:05 pm

SnowNovel wrote:
Fri Feb 01, 2019 4:49 pm
I have a pile of money I could use to pay down my mortgage and eliminate PMI. Alternatively, I could just invest the money. I'm trying to understand how to choose between the two options.

If the mortgage did not involve PMI, it would be a pretty straightforward decision. Do I bet that my investments will return a higher interest rate than that of the mortgage? If so, then invest. Otherwise pay down the mortgage.

With PMI, I don't understand how to perform this calculation. Once PMI is eliminated, suppose that I will pay that amount extra into my investments. That impacts my investment gains. But I'll also pay less interest on the mortgage. How do I run a calculation around those factors?

As an extra bonus wrinkle, I could also re-cast my mortgage for a $250 fee after the pay down, freeing up even more money per month for investing.

Some real numbers to play with, if that helps.

Home value: $418,000
Original maturity date: 12/01/2047
Mortgage rate: 3.875%
Monthly payment: $2,097
Loan principal: $356,366
Monthly PMI: $121.82
PMI eliminated on request at principal: $334,400
Principal payment required to request PMI cancellation: $21,966

How do I calculate the "break even" percent at which it makes sense to invest the pile of money rather than paying down the mortgage? Does it make a difference if I expect to be in my house only 10 more years versus being in my house for 30 more years? Does it make a difference if I re-cast?

Not a PMI expert but I recall that PMI is required (for some if not all lenders) as long as/until the LTV ratio is 80%. IOW, once you owe less than 80% of the loan balance, you don't have to pay. If your loan balance is currently $356k, 80% of that is $284.8k.

Are they just being generous with you? The home value may or may not be relevant, since PMI protect's the lender's interest, which is independent of the market value. It's usually based on the purchase price.

ETadvisor
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Re: Choosing between eliminating PMI or investing

Post by ETadvisor » Mon Feb 04, 2019 11:18 am

Admiral wrote:
Sat Feb 02, 2019 3:05 pm
SnowNovel wrote:
Fri Feb 01, 2019 4:49 pm
I have a pile of money I could use to pay down my mortgage and eliminate PMI. Alternatively, I could just invest the money. I'm trying to understand how to choose between the two options.

If the mortgage did not involve PMI, it would be a pretty straightforward decision. Do I bet that my investments will return a higher interest rate than that of the mortgage? If so, then invest. Otherwise pay down the mortgage.

With PMI, I don't understand how to perform this calculation. Once PMI is eliminated, suppose that I will pay that amount extra into my investments. That impacts my investment gains. But I'll also pay less interest on the mortgage. How do I run a calculation around those factors?

As an extra bonus wrinkle, I could also re-cast my mortgage for a $250 fee after the pay down, freeing up even more money per month for investing.

Some real numbers to play with, if that helps.

Home value: $418,000
Original maturity date: 12/01/2047
Mortgage rate: 3.875%
Monthly payment: $2,097
Loan principal: $356,366
Monthly PMI: $121.82
PMI eliminated on request at principal: $334,400
Principal payment required to request PMI cancellation: $21,966

How do I calculate the "break even" percent at which it makes sense to invest the pile of money rather than paying down the mortgage? Does it make a difference if I expect to be in my house only 10 more years versus being in my house for 30 more years? Does it make a difference if I re-cast?

Not a PMI expert but I recall that PMI is required (for some if not all lenders) as long as/until the LTV ratio is 80%. IOW, once you owe less than 80% of the loan balance, you don't have to pay. If your loan balance is currently $356k, 80% of that is $284.8k.

Are they just being generous with you? The home value may or may not be relevant, since PMI protect's the lender's interest, which is independent of the market value. It's usually based on the purchase price.
They are not being generous. It is based on the home value $418,000 to eliminate PMI. You may need an independent appraisal.

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Blister
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Re: Choosing between eliminating PMI or investing

Post by Blister » Mon Feb 04, 2019 11:57 am

Yes this is a no brainer Eliminate the PMI
Everthing works out in the end. If it doesn't then its not the end.

Topic Author
SnowNovel
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Joined: Tue Dec 01, 2015 12:36 pm

Re: Choosing between eliminating PMI or investing

Post by SnowNovel » Mon Feb 11, 2019 11:23 pm

I don't think this is nearly the no-brainer that many commenters seem to think. After thinking more about this, I realized I can try to figure this out via an amortization schedule.

I downloaded an amortization schedule template and filled it in with my details. (I used https://drive.google.com/previewtemplat ... ode=public.) I'll walk through my logic. Maybe I'm missing something here?

If I change nothing, making payments as scheduled, PMI will fall off in July 2021. That means 29 more payments of $121.82, for a total of about $3532. In other words, if I can cancel PMI right now, I'll save $3532 in PMI payments. Sounds pretty great. Let's see how this looks in a few different scenarios.

Scenario 1: Remain in house for full 30 year term

In this scenario, putting down a lump sum of $22,000 towards principal results in an interest savings of $24,224. Of course, we also save the $3532 that we would have had to pay for PMI. So, paying down $22,000 towards principal saves us $27,757 over the life of the loan. Pretty nice!

Now, keep in mind, this "costs us" that $22,000. We could have stuck that in a retirement account instead. What interest rate would our retirement account need to pay us in order to make $27,757? I fired up a finance calculator and chose the I/Y option. (I used https://www.calculator.net/finance-calculator.html.) Given a desired Future Value of $49,757 over 28 periods, with a starting principal of $22,000 and no additional payments in, what interest rate do we need? Only 2.96%! Oops, we'd definitely expect that a reasonable retirement portfolio would make more than that averaged over 28 years.

In this scenario, paying off PMI was a mistake and cost us money.

Scenario 2: Leave the house in 10 years

Let's say that we're only going to stay in the house for 10 years. After that, we'll sell it for exactly as much as we paid, just so we can avoid the confounding factor of gains or losses due to the home. This approach means that the PMI savings will be a much greater portion of the money saved due to the pay down. We'll also "get back" our $22,000, so we could choose to invest it then or roll it into a new house.

In this scenario, we'll only save $7822 in interest payments. Combined with that PMI savings, we'll save a total of $11,354 thanks to the lump sum payment.

Plugging this into the same calculator, using a desired Future Value of $33,354 and 10 periods, we calculate an interest rate of 4.29%. Okay, that's slightly more than a conservative retirement portfolio might be expected to earn. Paying down PMI might be a good bet in this case.

Scenario 3: Leave the house in 5 years

We save $4695 in interest for a total savings of $8227. Plugging a FV of $30,227 and 5 periods into our calculator, we find a required interest rate of 6.56%. I don't think I'd bet on 6.56% gain over an arbitrary 5 years in the market, so I'd choose to pay down PMI in this scenario.

Too Long; Didn't Read

This is the sort of post I was hoping someone else would make. :p Maybe no one made it because I did something wrong! If so, I hope you'll tell me.

totesmagotes
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Re: Choosing between eliminating PMI or investing

Post by totesmagotes » Tue Feb 12, 2019 12:15 am

SnowNovel wrote:
Mon Feb 11, 2019 11:23 pm
I don't think this is nearly the no-brainer that many commenters seem to think. After thinking more about this, I realized I can try to figure this out via an amortization schedule.

...

Too Long; Didn't Read

This is the sort of post I was hoping someone else would make. :p Maybe no one made it because I did something wrong! If so, I hope you'll tell me.
I didn't double-check your math, but it's good that you brought up the opportunity cost associated with paying down your mortgage more quickly than scheduled. In essence, you may be able to eliminate the PMI (and reduce total interest payments since you'll pay off the mortgage quicker), but one must look at the opportunity cost of doing so. More specifically, what else could you do with that money if you don't pay down to eliminate PMI? As noted, you can invest it. Over the long term, you may come out ahead by not paying down the mortgage and investing the money instead, which is what your calculations showed and was the purpose of your post.

yeahman
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Re: Choosing between eliminating PMI or investing

Post by yeahman » Tue Feb 12, 2019 12:38 am

SnowNovel wrote:
Mon Feb 11, 2019 11:23 pm
This is the sort of post I was hoping someone else would make. :p Maybe no one made it because I did something wrong! If so, I hope you'll tell me.
You forgot to add a return for the PMI and interest you would save.
Lump sum invested vs. PMI and interest saved and invested

bdpb
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Re: Choosing between eliminating PMI or investing

Post by bdpb » Tue Feb 12, 2019 6:37 pm

SnowNovel wrote:
Mon Feb 11, 2019 11:23 pm
Oops, we'd definitely expect that a reasonable retirement portfolio would make more than that averaged over 28 years.
A reasonable retirement portfolio is probably not the right benchmark. The right benchmark is probably high quality similar duration bonds.

See https://www.bogleheads.org/wiki/Paying_ ... _investing.

There are some other issues with your calculations but you'll have to wait for grabiner for the best thesis on the topic. There are a ton of other posts on the same topic https://www.google.com/search?ei=yFZjXJ ... HNpmiNmpMk.

Paying down a mortgage to eliminate PMI is almost always a winning proposition.

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8foot7
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Re: Choosing between eliminating PMI or investing

Post by 8foot7 » Tue Feb 12, 2019 7:02 pm

As I and others stated earlier, paying off the PMI is the way to go.

Paradise
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Re: Choosing between eliminating PMI or investing

Post by Paradise » Tue Feb 12, 2019 7:30 pm

You didn't state what the investment is? If it's corporate match 401k, not such a no brainer.

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grabiner
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Re: Choosing between eliminating PMI or investing

Post by grabiner » Tue Feb 12, 2019 9:40 pm

If you get rid of the PMI, you get a 11% risk-free return until the PMI would have otherwise been eliminated, and a 3.875% risk-free return beyond that. You could view this as a single bond. For example, if it would take three years to eliminate the PMI by paying on schedule, and you stay in the house another nine years, your return is 3/12 of 11% and 9/12 of 3.875%, which is about 5.6% on a 12-year bond. That is a very good rate, so you should do that in preference to any unsubsidized investment (401(k) with employer match, Health Savings Account if eligible). Once the PMI is gone, you will have more money to contribute to your 401(k) and IRA.

The worst case for an early payment would be if you eliminate the PMI, and pay off the rest of the mortgage on schedule, never refinancing, never paying extra principal, and staying in the house until the end. Shortening the mortgage from 28 years to 24 is equivalent to buying a 26-year bond portfolio, since you get the benefit only after that time. But even then, the three years (or whatever) at 11% are a huge return, and the risk-free 3.875% for 21 more years isn't bad.
Wiki David Grabiner

bltn
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Re: Choosing between eliminating PMI or investing

Post by bltn » Tue Feb 12, 2019 10:04 pm

mighty72 wrote:
Fri Feb 01, 2019 4:59 pm
121*12~1440
1440/21000~7%
7+3.875% = 10.875
It is a 10.875% guaranteed rate of return if you get rid of PMI + interest saved

This is crude math and others are free to poke holes in it. There might be tax advantages of not paying do.

But to me, getting rid of PMI is no brainier.
This is exactly the way I look at it. Get rid of the PMI.

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