Bad Finance to put 20% down on House

[Nissan350]

Guidance has always been to put down 20% when purchasing...

My friend is buying new house and is just putting enough down to get to 510,000 conforming limit. It would take him another 70k to get to 20%. PMI is only 100 per month less than 2% return on the 70k to cover PMI.

His rate is still only 2.75 with no points paid

So if PMI doesn't scale with the size of mortgage, I was paying 100 a month PMI on an 80k rental property recently, why put down 20% with rates this low.

Looks like normal market returns on the 70k even cover difference in payment.

Some food for thought.

[tooluser]

I don't know how it works now, but you used to be able to get a HELOC to make up the difference to 20%. When I bought my house 18 years ago, I put 3% down, had a 17% HELOC, and the rest was a fixed rate loan. No PMI. The HELOC and loan were from the same lender. You had to pass all the lender's debt to income ratios to qualify.

This is when they were writing $500k loans to minimum wage earners though.

It worked out well for me, but I was glad to refinance later.

[invest4]

Looks like normal market returns on the 70k even cover difference in payment.

Except when market returns are not so normal. Leverage can be good, but meh to taking PMI in doing so.

[Brianmcg321]

PMI doesn’t go into the house. It’s mortgage insurance. It’s wasted money.

[momvesting]

But remember, you have to double count what the $70k is costing you. It isn't JUST $100/month, It is $100/month plus 2.75% interest (another ~$160/month to start, decreasing by amortization).

[Nissan350]

Think the point is you only need a 4.5% return first year prior to any tax deductions to cover the PMI and Additional interest and that return requirement decreases each year. You get to keep 70k more liquid.

I guess I had assumed PMI would scale with dollar amount delta to the 20% requirement seems it doesnt.

[soxfan10]

Think the point is you only need a 4.5% return first year prior to any tax deductions to cover the PMI and Additional interest and that return requirement decreases each year. You get to keep 70k more liquid.

I guess I had assumed PMI would scale with dollar amount delta to the 20% requirement seems it doesnt.

Not all lenders require 100% coverage - that is likely the difference. I've generally been in the roughly 25-30% coverage depending on lender (initial lender was 25%, refi 30%). Ends up being ~$125 a month on a ~$650k mortgage balance. Agree with the OP, in a lot of cases its really not worth worrying too much about.

[aristotelian]

If he ever needs to sell in an under water situation he would be glad he put down 20%.

[grabiner]

Think the point is you only need a 4.5% return first year prior to any tax deductions to cover the PMI and Additional interest and that return requirement decreases each year. You get to keep 70k more liquid.

I guess I had assumed PMI would scale with dollar amount delta to the 20% requirement seems it doesnt.

This depends on the loan terms. If the PMI doesn't scale down, the cost of the PMI increases beyond the extra 2%, because you pay the full PMI on a smaller baance. If the PMI can be eliminated by paying down the loan, you get a very high return on the prepayment, ad should do that when you have the liquid funds. If the PMI cannot be eliminated until the mortgage would reach 80% LTV on the original amortization schedule, you are stuck paying the full PMI amount for longer than you keep the money, which makes the cost even more than the 4.5%.

But even 4.5% is a very good risk-free return, particularly since the 1.75% that is PMI is a short-term return because the PMI payments will only be made in the first few years of the loan.

[drk]

I don't know how it works now, but you used to be able to get a HELOC to make up the difference to 20%. When I bought my house 18 years ago, I put 3% down, had a 17% HELOC, and the rest was a fixed rate loan. No PMI. The HELOC and loan were from the same lender. You had to pass all the lender's debt to income ratios to qualify.

Piggybank mortgages are still around, but as I understand it you have to put down 10%. That HELOC on non-equity is, well, interesting.

[WS1]

From a VERY recent quote

5% down - PMI is 35bps of initial loan balance
10% down - PMI is 25bps of initial loan balance

I don't know if the PMI is recalculated as the loan balance decreases or if it's a fixed premium amount until you cancel it, but now you know.

-edit: the premium stays the same for the entire time you carry PMI
-edit: STOP WONDERING HOW PMI WORKS. THIS POST HAS ACTUAL QUOTES FROM A MORTGAGE BROKER

[dsmil]

I don't mind putting less than 20% down and paying some PMI, especially if they can clearly afford the mortgage. At 2.75% plus PMI for some years, it's still a good deal historically and he might sleep better at night with the extra cash (or investments).

I like this website to check PMI costs (https://www.hsh.com/calc-pmi.html).

[TropikThunder]

I don't know how it works now, but you used to be able to get a HELOC to make up the difference to 20%. When I bought my house 18 years ago, I put 3% down, had a 17% HELOC, and the rest was a fixed rate loan. No PMI. The HELOC and loan were from the same lender. You had to pass all the lender's debt to income ratios to qualify.

Piggybank mortgages are still around, but as I understand it you have to put down 10%. That HELOC on non-equity is, well, interesting.

It’s an HLOC (there’s no E).

[BestCoast123]

You're ignoring leverage. Is your mortgage recourse? Buying something with 20 to 1 leverage is pretty brilliant when real estate only goes up. Not very much fun when the market goes down. (Economy / housing markets certainly aren't feeling the pain of a recession yet either...)

[Lee_WSP]

Well the total mortgage payment is a question of cash flow. How much to put down has to do with net worth and how much liquidity you want.

The question of PMI if you can comfortably afford to skip it then becomes a question of expected return. Which then comes down to whether you think you'll get a better ror from the stock market.

[JoeRetire]

So if PMI doesn't scale with the size of mortgage

It doesn't?

I don't know, since I never paid PMI.

This https://www.investopedia.com/mortgage/i ... avoid-pmi/ indicates that PMI "typically costs between 0.5% to 1% of the entire loan amount on an annual basis". That's money I never want to pay.

[celia]

I look at it as how much more interest you will pay over the life of the loan. Even if interest is deductible on your taxes, it is still ‘wasted’ money you didn’t have to pay, IMO.

That’s like saying I have a big medical expense. Look at how much that will save on my taxes. Woohoo!

I would rather avoid both of these.

[baverage]

I was in a very similar situation earlier this year and it was an easy decision to put 10% down and pay PMI. The investment returns from the 10% we didn't put down should, on average, exceed the fairly minimal PMI, which is a plus - but it's likely not going to make a massive difference either way over the years we'll be paying PMI.

Far more importantly, I value keeping that extra 10% liquid today much more than anything else - I'd much rather keep the cash liquid (for investments for us, but could be spending for others) vs. worrying about the implications if we need to sell in some unspecific down scenario in some unspecified future. And even in that scenario, I'll likely be better off by keeping that 10% invested and not tied up in the house.

[hackermb]

The main take away from this post should be:

Not paying PMI in the short term costs you significant liquidity risk and doesn't return any real cost savings to the buyer.
Not paying PMI in the long term, based on historical market averages, is a worse financial decision and will increase your effective housing costs.

The two points are counter to everything Boglehead but sound financial advice. Which means in this situation following the boglehead approach would put you in a worse financial situation.

With rates this low and PMI rates this low it seems almost always better to keep as much money as possible out of an illiquid fixed asset.

[petulant]

As grabiner pointed out, PMI is often a flat amount no matter how much LTV actually goes down before PMI drops off. Here's a quote from a Bankrate article on PMI, emphasis added:

The average annual PMI premium typically ranges from .55 percent to 2.25 percent of the original loan amount each year, according to data from Ginnie Mae and the Urban Institute. With these rates, it means that for a $200,000 mortgage, your PMI can cost between $1,100 and $4,500 each year, or around $91.66 to $375 per month.

This is not the same thing as, say, FHA insurance, which reduces the monthly premium each year based on the forecasted amount at risk for that year.

So in the early months, PMI can seem like a reasonable deal, but it will eventually become more and more advantageous to prepay and drop PMI. Anybody who suggests getting PMI and then doing nothing is peddling bad finance.

Whether it's a good idea to do PMI depends on the numbers and one's risk preference. For example, in the OP example, say the PMI premium is truly $1200 per year based on the $70K balance difference. That's almost 4.5% as others have pointed out, which is a good fixed rate number but could be outperformed by stocks. However, note that stocks are not risk-free investments. It is frankly not a good idea to borrow at 4.5% in order to buy stocks.

Even if you think it is a good idea, it won't stay at 4.5%. Let's say we move along three years, when an amortization schedule shows that the mortgage will have about $475,000 left. So $35,000 has come off, and if the house value hasn't moved, the owner is paying about $1200 / 35000 + .0275 = 6.2%.

Barring a short-term liquidity need, it's bad finance to get PMI. Even if you do, you need an exit strategy.

[BestCoast123]

I was in a very similar situation earlier this year and it was an easy decision to put 10% down and pay PMI. The investment returns from the 10% we didn't put down should, on average, exceed the fairly minimal PMI, which is a plus - but it's likely not going to make a massive difference either way over the years we'll be paying PMI.

Far more importantly, I value keeping that extra 10% liquid today much more than anything else - I'd much rather keep the cash liquid (for investments for us, but could be spending for others) vs. worrying about the implications if we need to sell in some unspecific down scenario in some unspecified future. And even in that scenario, I'll likely be better off by keeping that 10% invested and not tied up in the house.

Likely yes. But now your house is levered up 10 to 1 instead of 5 to 1. Which is fine but every thread on this ignores the huge risk involved.

[sunny_socal]

I've did an 80/10/10 mortgage to purchase our last house:
- 1st mortgage is 80%, conforming
- 2nd mortgage is 10%, expect slightly worse interest rate

Done! Only 10% cash down. Refi the 2nd when it is convenient (we paid ours off after selling another house.)