Should I pay private mortgage insurance out of pocket or finance the cost?

Aug 12, 2022 Keith Gumbinger,HSH.com

Q: We are trying to determine the best course of action to pay for mortgage insurance when we refinance. We can pay the insurance premium of $3,160 out of pocket (we have the funds), and get about 4 percent interest rate on the loan of $213,750. Or we can have the mortgage insurance rolled into the loan with an interest of 4.375 percent. I'm getting conflicting thoughts and am interested in a recommendation.

A: For the most part, this is a calculation regarding time. You should compare the total costs of the difference in the two interest rates over your given time horizon.

To do so, you'll want to use HSH.com's Tri-Refinance refinance calculator. You can compare paying costs out-of-pocket, building them into the loan amount (called a low cash-out refinance) or trading them off for a slightly higher interest rate.

Paying them out of pocket today provides a lower rate. That lower rate translates into savings over time compared to the other two methods. The question you are looking to answer is "When do I get my money back and actually start to save?" The difference in the interest rate at your loan amount produces a monthly payment difference of about $46.75 per month. At that rate, and on a simple "payback" basis, you'll get your money back in about 67 months.

However, the lower interest rate has additional benefits beyond the simple difference in your monthly payment. You'll pay considerably less interest at 4 percent than at 4.375 percent over time and actually own more of your home sooner. After 10 years, for example, you'll have spent $84,820.74 in interest at 4.375 percent and still owe $170,504.02; at 4 percent, that would be only $77,107.73 and $168,400.71 respectively. In essence, you'll have spent $3,160 to get back $7,713.01 in interest plus $2,103.31 in equity, putting you $6,666.32 ahead once your $3,160 outlay is subtracted.

With regards to time, it's not clear why you might want to pay the mortgage insurance premium in one lump sum or choose a Lender-Paid Mortgage Insurance (LPMI) arrangement. In either method, the MI cannot be canceled even when the mortgage's loan-to-value ratio sinks below 80%, an event which will occur over time.

In a more conventional borrower-paid mortgage insurance arrangement, premiums are made monthly as part of your mortgage payment, and when a combination of home value appreciation and amortization drop your LTV below 80%, you'll be able to cancel the PMI policy, That may ultimately cost you less than either of the other choices, and can happen in as little as two years if market conditions work in your favor.

Run your own calculations and compare different time scenarios to meet your needs.