Cost of Private Mortgages

So what are the costs of a private mortgage insurance? Should you place your money in a larger down payment to avoid the costs of a private mortgage insurance or should you invest it in other avenues providing you have this extra money lying around?

Private mortgage insurance costs around .79% of the balance per year for the first 10 years then it declines to .20%. So with this in mind let's take a look at an example. Suppose we purchase a $100,000 home with 30-year fixed rate mortgage at 7.5% and zero points. We have can borrow $80,000 or 80% of the purchase price with no private mortgage insurance or we can borrow, say, $95,000 or 95% of the purchase price with private mortgage insurance.

Let's assume we borrow $95,000. An easier way to view the costs of a private mortgage insurance is to break the loan into two loans: the first loan is $80,000 borrowed with an interest rate of 7.5%; the second loan is $15,000 with an interest of 7.5% plus the private mortgage insurance premium. The second loan is what we are interested in. The interest costs on the $15,000 loan will be 12.7% for the first 10 years of residence and then it drops to 12% if you stay for another 20 years.

How did we get 12.7% for that second loan when we said it would be only 7.5% for the interest with an additional .79% for the private mortgage insurance? The .79% applies to the entire loan of $95,000 and not only the $15,000. The percentage cost of the second loan (also known as incremental loan) will vary depending on the amount. For example:

A second loan of $5,000 or $10,000 the cost is 13.4% and 12.5%, respectively. Eventhough the private mortgage insurance premium is lower, the incremental loan is smaller. This means that percentage cost of the second loan will differ.

If the second loan is smaller yet the private mortgage insurance premium remains the same then the cost is higher. Thus, an $11,000 fixed-rate loan with a the same private mortgage insurance premium as a $15,000 fixed-rate loan will have a cost of 14.3%.

Note adjustable rate mortgages have higher private mortgage insurance premiums and, consequently, higher costs then fixed-rate mortgages.

The private mortgage insurance costs can be reduced if it's removed early. So if the private mortgage insurance is removed for a $15,000 second loan (i.e. 95% fixed-rate mortgage) by, say, investing in your home equity within 5 years but you remain in your residence for 10 years than the percentage cost of the private mortgage insurance premium declines to 10.8%. On the other hand, if you move in 5 years and pay off your mortgage you will see no savings.

Here is the calculation cost of the private mortgage insurance (if the loan is greater than 10 years):

((Total loan / Second Loan) x private mortgage insurance premium) + mortgage interest rate = cost of private mortgage insurance

So, for our example:

(($95,000/$15,000) x .0079) + 7.5% = 12.5%

Now, the question is whether you should place a larger down payment of $20,000 for a $100,000 home and borrow $80,000 without paying private mortgage insurance or borrow $95,000 for a $100,000 home and pay the private mortgage insurance. What is the wiser investment decision for you?

So using the example mentioned previously, if you have an extra $15,000 should you invest it in the stock market or should you place the money for a larger down payment? Well, if you were to invest it in a stock portfolio then you would need to create a return of investment (ROI) of over 12.5% since that is the cost of the private mortgage insurance. The average return of investment is around 5%. The only con in allocating $15,000 cash in home equity ties up your money and the cash is illiquid as opposed to your stock investment.

The financial costs of a private mortgage insurance are easy to calculate; however, the factors to consider into costs are the risks you are willing to take in the allocation of your funds. You may feel that investing in your business will reap greater returns than the 12.5% costs of the private mortgage insurance. Or you may risk the 12.5% cost of the private mortgage insurance if you feel the home you are investing in will appreciate and is thus a good investment decision. The decision will ultimately be up to you after you factor in all the financial avenues you have and assess the risks of each.

Guttentag, Jack. "What is the Real Cost of Mortgage Insurance?"
http://www.mtgprofessor.com/

Best Mortgage Rates

Costs of Private Mortgages
Stop Paying Private Mortgages
Avoid Paying Private Mortgages
Mortgage Interest Tax Deductions