Why PMI Isn't As Terrible As You Think

Certified Mortgage Advisor
NMLS 1701021
January 6, 2022

What is PMI?

As you've been looking into buying a home and getting a loan, you've likely heard of the term PMI and it stands for Private Mortgage Insurance.

PMI on Conventional loans

Basically what PMI is something that's required on conventional loans. It's on other loans as well, but we're mainly talking about conventional loans because they will fall off on conventional loans. So it's required on conventional loans.

20% down

If you have less than 20% down, as soon as you have 20% down that PMI, private mortgage insurance can be removed.

Protects the lender but not the borrower

But what it does, PMI only protects the lender. Doesn't actually protect you. So it protects the lender in case you default. So if you don't pay back your loan and they have to foreclose, it's an insurance that the lender basically helps them recoup the money that they lost. However, you're the one footing the bill for it.

Why do we need PMI?

So most people think, why would I want to get alone with private mortgage insurance when I could save 20% down and then buy a home that way and never have to pay the private mortgage. And they see PMI as this really expensive cost because it can be, you know, a couple of hundred dollars per month. And of course, we want to save as much money as possible.

Free Calculator

But I want to show you a tool. Here's a free calculator that you can use: PMI calculator as we walkthrough through how we can use PMI. You can strategize it in a way, so that's actually an investment for you instead of it just being something that is an expense.

Most people think about it just as a monthly expense, they don't think about it in the opportunity that it gives them to buy a home. So we're going to compare the scenario. The scenario is, and this, again, here is the link for you to download for free: PMI calculator.

What's our target with this math

The scenario is to save 20% or buy now and pay private mortgage insurance. So we could say, I'm going to wait to buy in the future and put money into savings, or I'm going to buy now and choose to pay PMI. We want to look at the math of what this actually means for us. Instead of just going off of our gut feeling of PMI is bad. I'm going to save 20% down.

How we can use PMI as an investment?

So private mortgage insurance is required on conventional loans. When you have less than 20% down, PMI only protects the lender. So most people view PMI as a burden, but if we look at it mathematically, it can actually be used as an investment.

The scenario

So what we want to do is we want to put in our scenario first. So we're just looking at conventional loans because PMI will fall off of conventional loans. Usually when you have 20 to 22% equity in the home, On loans like FHA, usually you have mortgage insurance for the entire duration of the loan. Same with USDA and VA does not have monthly mortgage insurance.

Purchase price

So for our home purchase price, you can put an estimate in here. I also have a calculator that can help you see what an estimated max purchase price is depending on your scenario, here's the link: Max Purchase Price Calculator. But for right now, for this example, we'll go with let's say we're going to go with $425,000 as a purchase price that we're looking at.

Now we want to put in, if we could buy a home right now, what was the minimum down payment we would use? So 3% is the minimum for a conventional loan for first-time homebuyers. Let's say we're looking at 5% down. So that would be $21,250. Then for our interest rate, check out WintheHouseYouLove.com - RATES.

So for example, today's 30-year conforming loan average in the US is 3.42. So we'll run 3.42, and then it will tell us 0.65% of the loan amount is typical for mortgage insurance. So that would be $219 per month.

We can adjust our PMI monthly cost

Now in here, you can make that higher if you want to or lower, if you want to, you'll want to shop with different lenders to find what mortgage insurance is going to run for you. But if you're looking at competitive lenders, $219 is going to be a really good estimate here. Then the length of the loan, 15 years, 20 years, 30 years, whatever that looks like.

The question of concern

So from this scenario, what we're saying is if we bought a home today, this is the scenario that we would use. So, what we're comparing is, is it better to buy now or is it better to wait to save 20% down. Because right now we only have 5% saved. Is it better to save the additional 15% over a period of time? And then by that way, we don't have to pay mortgage insurance.

So let's look at what this looks like. 21,250 is 5% down to get to 20% down. We need to save $85,000. We have $63,750 left that we need to save. To reach $63,000. How long will it take you to save that amount of money? Maybe that's 24 months, right? You're looking over here and saying $2,600 a month. There's no way I can do that. Maybe it's 48 months. Can you save $1,300 per month into savings? That's a saving that's required to get you to 20% down to not have to pay mortgage insurance.

Yes, home value increases when you wait... now what?

Now what we want to keep in mind is let's say we're rolling with 48 months here over 48 months. Appreciation is likely going to increase the home value and historic appreciation or the past 30 years has been 2% every single year. That's including the 2008 housing crash. We have that number here as well. You can adjust this if you'd like, you can go 1% or 3% or do whatever you'd like here. 2% is a historic 30-year appreciation. So 2% appreciation over 48 months, which is how long you were saying it. At worst it's going to take us to save that amount of money that would make a $425,000 home worth $460,000 and increase the needed down payment by $7,000.

So even though we set our savings goal was 1300. It actually needs to be closer to 1475 for 48 months to keep up with the home appreciation as well. And so if that's too high that we can increase the file "I can save". So maybe we need to bump that up to 55 months, and this is going to change depending on your scenario and maybe get some bonuses in there as well. We're just going to run off of these averages for now.

So let's bring this to 48 months, just for the sake of the example. So, what we're saying is we have two options here. We could wait 48 months to buy a home and put 1475 per month for 48 months into a savings account. Then in the end, once we have all that money for 20% down, we buy the home and we don't have to pay PMI, or we could buy the home now with 5% down.

We were already saying, we going to save $1475. Into a savings account. What if we actually prepaid the principle of our mortgage, we buy the home and then we pay into the principle of the mortgage. What would that do? So we're basically treating our mortgage, as the savings account instead of a savings account and then buying the mortgage.

Two options

So Option A is buy in 48 months, but 20% down and that's 20% on that appreciated value of the home and then put 1475 per month for 40 months, or Option B is by now put 5% down, which is around $21,000 and then put 1475 for 48 months into the mortgage. What difference would that make here?

Option A

So Option A, waiting to save 20% down in 48 months. The value of the home you're looking at would increase by $35,000 and you need an additional $7,000 in your down payment just to be able to buy the home. On the plus side, though, your monthly payment would be lower by $158 per month in principal and interest. Not to mention you wouldn't have to pay the $219 per month in PMI.

Buy now or later?

Now, what we want to also consider is we're not comparing the interest savings of a 20% down a loan because the more down you put, the more interest savings you're going to get, but we're not comparing is 20% down, better than 5% down. We're comparing buy now versus buy later. So the home value increases in 48 months. The monthly payment decreases, but the down-payment increases as well.

Option B

Now, option B is to buy now and pay PMI. So to avoid PMI and put 20% down on a home, you need to save $1475 per month for 40 months. Instead, you could buy a home now and put that savings directly into the mortgage principal each month.

This will help you take advantage of home appreciation and remove private mortgage insurance quickly. So, that is what the P and I payment look like and PMI payment it looks like.

What's the better deal?

But what's interesting is in 48 months, we bought the home. We've owned it for 48 months and we've been putting $1475 into the principal balance. We would have gained $35,000 in appreciation based on that 2% year-over-year appreciation, we would have paid $5,200 in PMI. Already, this is a much better deal. The PMI was just a cost for us to be able to take advantage of appreciation. Then we have to keep in mind too, that when mortgage insurance gets removed because of the home value increasing, we're going to need a new appraisal done because the lender is going to base the value of your home on the purchase price and not on what the new of value would be because they don't have an appraisal.

We have to pay for an appraisal in the future

Even factoring that in, we have a net benefit of almost $30,000 instead of waiting to save 20% and then buying. So in my chart, the appreciation gain over that 48 months, and the cost of PMI became flat.

Why PMI did not go straight up?

Something interesting that happens here is it flatlines. It's because PMI actually falls off after two years because of this strategy. Before, if you didn't have anything paid into the mortgage, PMI would have fallen off after 50 months, but because you were paying this extra money into the mortgage, it falls off after 24 months.

Don't miss the 2% historical appreciation

So because we bought the home now and chose to pay PMI, it costs us money, and I think what a lot of people do is they're like, well, it's gonna cost me $5,200. But you also get to gain the historical appreciation that we've seen at 2%. If that increases, then you're seeing an appreciation of $35,000 that you would have missed out on if you only put that money into a savings account.

Think and act like an investor

This is very similar to how investors trade with margin accounts or with stocks. So a lot of savvy investors will actually take out loans to invest in the stock market. So if they're taking out a loan, let's say at 6%. But in the stock market, they earned 10%. They actually gained 4%. It's the same thing that's happening here with PMI. You're going to pay interest on the loan, no matter if it was 20% down or 5% down. So the difference with the 5% down is you have the PMI cost with it. So PMI in this instance is 0.65% of the loan amount and appreciation is 2% of the purchase price. So already there's this huge difference. You are always going to be on top as long as the appreciation is higher than the PMI cost percentage.

Do what works for you

So in that instance, PMI almost always is really easy to use and strategize as an investment. Now, maybe you're looking at this, anything you'd like to ask still, I don't want to pay PMI. That's perfectly fine. You do what works best for you. Just understand this is how the math works out.

If we're looking at historical data, we're not trying to make anything seem bigger than it is, right. We're not using, you know, appreciation last year was around 15 to 17% across the US we're not using crazy numbers like that. We're using the historical average of 2%. So we're not going totally off base here. We're just looking at what does the data tell us about these two decisions.

This is an option if you don't have 20%

Of course, the higher. It gives you the most interest savings, but that's not what we're looking at right now. If we were comparing 20% now, versus 5% down, 20% down is always going to win.

But in this scenario, you don't have 20% down. You have maybe 5% down or 3% down. Should you wait to save 20%, so you don't have the cost of PMI, or do you leverage PMI as an opportunity to help you use your home to gain that appreciation where otherwise you wouldn't have been able to have it?

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