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PMI (Private Mortgage Insurance) isn’t all bad–and I can prove it with simple math 

You may not know my name, but I am Craig Curelop. I’m also known as The FI Guy, and the author of The House Hacking Strategy. During my house hacking adventures, I receive a great deal of questions and hear a number of excuses. One of the most common excuses that I hear is “I don’t want to pay for private mortgage insurance.”

What is PMI?

private Mortgage Insurance is a monthly charge that’s added to the mortgage cost when the borrower doesn’t put down more than 20% on a primary home. PMI was created to protect banks from a repeat of 2008 when they lent 120 percent of the value of a home to people who had no income, no job, or assets.

You are more likely to default on your loan if you put down less than 20%. Your principal balance will be higher. To protect themselves from this, the bank added primary mortgage insurance.

The cost of PMI is determined by the purchase price of the home. You will pay between 0.5 and 1 percent per year of the loan value in PMI, depending on your credit score. Here’s an illustration.

If you purchase a home for $315,000, and pay 5% down, your total loan would be around $300,000. The PMI is therefore $3,000 per annum or $250 per monthly.

This article will compare the financial situation of two different types of House Hackers. Let’s assume that the first person used the low-down payment method and paid PMI, while the second person put down the standard 20 percent.

Before we begin the comparisons, let’s make a few assumptions. The assumptions for each example will be the same, with the exception of PMI (private mortgage insurance) and down payment.

  • Savings per month: $1,000
  • Purchase Price:$315,000
  • Interest rate: 4.55%
  • PMI : 1 % per annum or $250 per month
  • Insurance: $150
  • Taxes: $180
  • Appreciation: 3%

House Hacker who Does Not Pay PMI

Meet Alex. Alex is eager to start his first house hack, and does not care if he has to pay PMI. He already has money in his savings account, but wants to add an extra $15,000 as a down payment. After 15 months he has enough money to pay the down payment for a conventional 5 percent loan.

He decides to go with this strategy for his first transaction. He buys a single-family home with five bedrooms and three bathrooms for $315,000, and pays 5 percent. The monthly payment for his home is $2,100. This includes PMI at $250 per month.

Alex can rent the remaining four rooms at $700 per room, and collect a total rent of $2800. He puts aside $400 in reserves and has a monthly cash flow of $300. Even with PMI, his true cash flow is $1000 per month after you take into account his rent savings.

Alex, being a smart person, does not change his lifestyle. He saves $1,000 as he did before, AND the $1,000 extra from his house hack. Now, his total savings per month is $2,000. Alex’s total monthly savings is now $2,000

We will assume, because he is fond of this method, that he can earn $1,000 more in cash flow with every additional house hack.

Visit our friend Kaylee who doesn’t pay PMI.

House Hacker who does NOT pay PMI

Kaylee has a conservative outlook. She is fascinated by the idea but intimidated when she hears that an additional $250 per month will be added to her mortgage. She decides to pay the standard 20 percent deposit in order to avoid this.

Kaylee, like Alex, saves $1,000 a month through her job. She wants to buy a property similar to Alex’s: a three-bedroom, five-bed house that she could rent to others to pay off her mortgage. Kaylee would need to pay $63000 up front with 20 percent to avoid PMI.

If she saves $1,000 a month, in 63 months (5.25 years) she can buy her first home. If the price of the property remains the same, she will pay $1600 per month when she buys her first home. It is clear that PMI was not included, and she pays interest on a smaller loan because she paid more.

Kaylee pays the same rent as Alex. She lives for free and collects $2800 in rent. She makes $1,500 in rent per month after setting aside $400 as reserves.

Kaylee, like Alex, does not change her lifestyle. She continues to save $1000 and adds another $1500 from her home. Now, her total monthly savings is $2,500. To save for her second house hack she will have to again save $63,000. She will have to wait approximately 25 months, or two years.

Compare

Alex and Kaylee make different decisions. Alex’s cash flow is $500 lower than Kaylee. Kaylee, on the other hand, has to wait five years before she can save up and buy her first house hack.

If Alex purchases a similar house hack each year he will end up with five properties, and $5,000 in monthly cash flow compared to Kaylee’s $1500. In the seventh year, Kaylee can purchase her second home, bringing her cash flow to $3,000 and Alex to $7,000.

Kaylee can buy her next property with just 20 percent of the purchase price in year 8, after her third house hack. This is exactly what Alex does. If they continue to purchase one property each year at the same pace, Kaylee will have a higher monthly cash flow than Alex after 18 years.

Who the hell wants to be a house hack for 18 long years? Even I wouldn’t want to do it.

This study assumes Alex purchases only one house hack per year or rental property. Alex will save over $96,000 a year by the time Kaylee buys her third house hack in year 7. He can buy a house hack AND rent a traditional property, increasing his cashflow by $2,500. Kaylee, on the other hand, sees her cash flow only increase by $1,500 per property.

Alex will be able purchase more property per year than Kaylee. This means that she will never catch-up!

The conclusion of the article is:

Do you now understand why PMI is not important to me? You will waste a lot of time if you wait to pay down the 20 percent. It is unlikely that one property will get you financial freedom. It’ll take several. If you want to achieve financial independence and create wealth in the shortest amount of time possible, then house hacking is the way to do it!

The low down payment is what makes house hacking powerful. I’ve never seen another investment where you could put down as little as 3 to 5 percent, or $15K, and still get $1,000+ per month in cash flow. Not to mention the other benefits that real estate offers, such as tax advantages, loan repayment, etc.

This article should help you decide if PMI is right for you. Enjoy your investment!

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