Wednesday, June 24, 2009

Is PMI Really as Bad as They Say?

The voice of Suze Orman rings out in my head warning me not to buy a house without at least a 20% down payment to avoid paying Private Mortgage Insurance (PMI). But, if we truly investigate PMI in regards to the average first time home buyer is it really that bad? Most of you probably feel that throwing away hundreds of dollars a month is crazy, but it might be the lesser of two evils when it comes to renting, and here is my rational why.

PMI is a fee that lenders charge to cover the risk of financing a home with less than 20% down. Once the home has accumulated 20% in equity, the fee can be cancelled, but not refunded. Since most first time home buyers don't have $59,000.00 laying around to put down on a $292,600.00 home [National Average used per], many of us resort to paying PMI.

I unfortunately have to pay PMI, which cost about $200.00 a month until the house appreciates 20%, or until I gradually pay off 20% of the principle which should take about 11years. This means that I am potentially throwing away $26,400.00. It may sound absurd, but lets see what would have happened if my wife and I decided to continue renting to save money instead.

Our old modest 2 bedroom apartment was nowhere near as nice as our home, but for the sake of argument it cost us about $1200.00 a month to rent. Like PMI, once that rent money was paid it would never be seen again. The longer it takes to save up for the down payment, the more we would be spending in rent. Just to break even, we would have to save $59,000.00 in 22 months. I don't know about you, but setting aside an extra $2600.00 a month for a down payment is not even feasible at my current pay scale.

Here is a closer look at the break even point:
$200[PMI] x 12 [Months] x 11 [Years] = $26,400.00 [Total Cost]
$1200 [Rent] x 22 [Months] = $26,400.00 [Total Cost]

Here is a closer look at the rate of money needed to be saved before the break even point to be beneficial:
$59,000.00 [Down Payment] ÷ 22 [Months] = $2,600.00 [Per Month]

Let me know if I am crazy, but it appears that it's better for first time buyers without down money to just pay PMI rather than spend years renting and saving. What do you think? Am I missing something?

1 comment:

Anonymous said...

You are crazy. Your breakeven point is wrong, you can't count all your rent towards it, you have to subtract the non-tax refunding interest on your new mortgage and pmi payment. If your non-tax refunding interest + pmi = rent, you are at the break even point, the difference is your savings on either side... In general, any home equity loan is better than pmi...