Updated: Jan 6, 2018
Question: How do I know if it is cheaper to pay for private mortgage insurance or to put up a larger downpayment on a house?
If you already have the money for a down payment of 20% or more, you will avoid paying mortgage insurance (MI). From a simple payment standpoint, you will save money by making the larger down payment. Your payment will be lower because of the smaller loan amount AND not having to pay MI. The actual difference will depend on the loan amount you end up going with, and the rating for your MI. If you have great credit, you can expect to pay less in MI compared to someone with a lower FICO score. You can find countless articles urging you to avoid MI by putting at least 20% down, but is that really the best use of your money?
Think about how long it took you to accumulate your savings. In Hawaii, we have some of the highest cost of living, yet our wages are relatively low. It probably took many years of saving to get the kind of cash you have now...so do you really want to put it all towards your down payment just so you can pay less each month? Remember, as a homeowner you are now responsible for everything that comes with owning a home: replacing broken appliances, maintenance & upkeep, not to mention the mortgage payments!
There are a couple of reasons why you might want to make a smaller down payment, even when you have the cash available:
1) The first is to ensure you have enough funds for emergencies. If you get sick and can't work, or lose your job, do you have enough to keep you afloat for a while? If you use most of your savings towards your down payment, you are creating a big financial risk.
2) Another biggie is using it to pay off high-interest credit cards (revolving debt). In most cases paying down credit cards more than pays for the added MI and is an excellent way to make your new home more affordable!
3) The other thing you should consider is the opportunity cost of that money. Interest rates are at historic lows (just under 4% as of this post), whereas a typical diversified investment portfolio's rate of return can be anywhere from 7% - 11%. Remember, every dollar you put towards your down payment means less money earning a return in your portfolio. Smart buyers will leverage mortgage debt to keep their investment portfolio as large as possible, increasing their net worth over time. For a detailed illustration on how this can be applied, click here: http://www.relationshipplanner.com/admin/calculators/12806
4) Lastly, the amount of your mortgage has no affect on your home value! Home values are determined by other similar home sales in the area. Whether you have no equity or no debt in your home makes no difference when determining how the value of your home will appreciate over time.
You should also be aware that MI goes away after a while. It will drop off automatically once the loan is 78% of the home's original value, but with appreciation you could get it removed sooner, depending on the home's value.
Either way, enjoy the buying process. Buying a home should be a fun experience!