Most experts are wrong, Personal Mortgage Insurance (PMI) is a great investment

I’m a big believer in finding the right places for your money. In this post, I’m going to explain why Personal Mortgage Insurance, referred to often as PMI, is actually a great investment.

Most people get told early in life that they should save up for a 20% down payment on their home. That way, you don’t have to pay mortgage insurance. Well let me tell you, this advice is really wrong. Putting 20% down on your house is a wealth destroyer, and could cost you $100,000s over a 30 year loan. I’m going to show you how to create wealth by using half of that down payment as an investment.

First, let me tell you the reasons why putting a 20% down payment down on your house doesn’t make sense:

• The equity in your home doesn’t work for you. It doesn’t earn interest, doesn’t get market returns. This is equivalent to putting money under the mattress.
• If you want to access YOUR money, which is what your down payment is, you’ll need to refinance or get a home equity loan. Both of these will cost you money. Refinance fees, and potentially higher interest rates if you refinance. If you go with the home equity loan, you’ll be paying banks interest for the privilege of using your own money. Aren’t those banks great?

Now I’ll show you the numbers behind why PMI is a great investment. In this example, we’ll assume that you are buying a $500,000 house. You would need $100,000 down payment to avoid PMI. PMI generally is around .2-.3% of your loan value. I personally pay .24% PMI on my house. I’m going to show you how putting $50,000 down and investing $50,000, while paying $1,200 per year in PMI could make you almost $300,000 to $500,000 wealthier after 30 years.

The math and plan: $50,000 down payment, the other $50,000 invested, and $1,200 PMI payment/cost per year. Assume 9% Market return (the S&P 500 has averaged 9.8%, but we’ll be conservative with 9%).

$50,000 invested at 9% return for 30 years = $663,000 (let’s subtract 25% for taxes, and you’d still have $497,250). Now the PMI is an added expense each year, so let’s say that the extra $1,200 you’re paying for PMI also was invested each year and growing at 9%, that would = $164,000 after 30 years.

Now bringing it all together: $497,250 growth – $164,000 missed growth – $50,000 just sitting in home equity = $283,250 wealth created by leveraging PMI.

Growing wealth by $283,250 by having a payment of $1,200 is equivalent to a 12% annual return. Another benefit to growing wealth, is the money is in your hands the whole time. In case of an emergency, its liquid. You don’t have to waste time and money trying to get your equity out of the house.

The final benefit: there are many ways to keep the taxes on that growth under 25%. I used that number to prove a point, and the math still makes sense. Most people pay long-term capital gains tax of 15%, not 25%. This pushes your wealth growth into the realm of $300,000-$500,000 if we used current tax assumptions. Also, there are many ways to shelter your growth from taxes, through Roth IRAs, 529 plans, or other tax-sheltered accounts that I won’t discuss here. Think about that. This one decision could pay for your kids college.

I do want to revisit my decision above to put 10% down. People ask me, if the math is so good, why not put ZERO down? The biggest reason is that you may not be eligible for certain types of loans if you put nothing down. Other loans will cost you a lot more interest if you put less than 5% or less than 10%. I’ll give you an example. If you put 5% down, its possible the best interest rate you can get is 5.25%. If you put 10% down, you may be able to get lenders to compete for your business and offer 4.25% interest on the loan plus the PMI. That 1% interest savings = about $4,500 a year savings if you put 10% down. While the math can still work by putting less than 10% down, it will generally increase your monthly payment too much and many people may not be able to afford to save and invest in other areas if they’re too “house poor”, meaning your payment is too high and you’re not able to afford a good life.

The choice is yours. You can put 20% down to avoid a small PMI payment, or you can put your money to work for you, take advantage of compounding growth and come out much wealthier. That’s my goal here at Joey P Money: Make Money. Get Rich. Grow Wealthy