PMI. If you are a homeowner you are well aware of the meaning of this acronym. You might even shutter at the thought. Private Mortgage Insurance. If you take out a mortgage and cannot cough up at least 20% for a down payment, you will likely have to pay PMI. The purpose of the insurance is to protect the lender in case you default on your loan. Payments for your home are expensive enough when you consider the principal, interest, taxes and homeowners insurance. So it is infuriating to think that you may have to pay even more if you are subject PMI! It stands to reason that if you have the money and can afford to put 20% down to avoid PMI, you should.
Conventional wisdom might lead you to believe that you should. Certainly your good-intentioned parents, friends and neighbors would advise you to avoid PMI.
I am going to challenge conventional wisdom and suggest that you think again. Let’s take a quick walk through the numbers.
First of all, how much is PMI? The answer depends on many factors including the value of your home and your credit score. All other things equal, if you have a great credit score, your PMI could be much lower than it would be for someone whose credit is not quite up to snuff. Assuming your credit is in great shape, your PMI might be roughly 0.5% of the total value of your home each year. For illustrative purposes, we will use that figure for the following example.
Suppose you buy a home for $300,000. A 20% down payment would be $60,000. If you do not put down 20%, the annual PMI amount would be roughly $1,500/year (0.5% * $300,000). This is divided by 12 to come up with a monthly PMI amount of $125.
Option 1: Let us suppose you have the 20% to put down. That would be $60,000. You put down the $60,000 and avoid paying the yearly $1,500 PMI.
Option 2: You have $60,000 saved but you only put 5% down (which is $15,000). You invest the other $45,000 in stock-based mutual funds or ETFs earning an average return of 6% per year. A 6% average return is $2,700 per year.
Think about it, would you rather avoid $1,500/year, OR pay the $1,500, but receive $2,700?
I know what you are thinking, this analysis assumes a lot. And you are right. For this strategy to work you have to 1.) Have great credit, 2.) Have a 20% down payment saved, 3.) Be willing to invest the amount you have saved, and 4.) Achieve favorable market returns.
Yes, these things must all be true in order to make paying PMI advantageous. As for number 4, keep in mind that stock market returns averaging at least 6% over time is a reasonable assumption. But even if the stock market averaged 4% or 5%, you may still come out on top.
To further strengthen the argument, you might be able to cancel your PMI early! If your home appreciates in value, giving you more than 20% equity you can submit a request to your lender to cancel your PMI. (An exception is with FHA loans which generally do not allow you to cancel PMI early).
And if that was not enough, there is more! If your AGI is less than $109,000 you may be able to deduct part or all of the PMI you have paid, which is something else to consider.
While the numbers above may not reflect your unique situation, I hope it has given you some food for thought and, at the very least, lets you feel a little better about paying those pesky PMI premiums! As a reminder, be sure to consult with a financial advisor to provide insight on your own situation before you sign on the dotted line!
The views depicted herein are for information purposes only and are not necessarily those of Cetera Advisor Networks LLC. They should not be considered specific advice or recommendations for any individual.
The example above is hypothetical only, does not take fees and/or taxes into consideration and does not represent the actual performance of any particular investments. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions and when sold or redeemed, you may receive more or less than originally invested. There is no assurance that any investment strategy will be successful. Past performance is not indicative of future results.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.