Payoff Mortgage for Better Rate of Return?
There are pros and cons to paying off mortgages (or at least accelerating payments) and a lot of people feel pretty strongly about the subject. I personally avoid accelerating payments on the 2 properties I have owned up until now as I feel I can get a better rate of return elsewhere.
However the mortgage on my wife's townhome presents a new opportunity to do an evaluation on what my best "100% safe rate of return" could be.
Currently, I have established that my high yield savings account at EmigrantDirect is the best place to store my risk-free cash savings.
Here is the scenario with my wife's townhome.
The loan is a 30 year fixed, FHA loan with 3% down, with an interest rate of 5.875%. The loan requires PMI until the loan balance reaches 78% of the original appraisal. There doesn't look to be any costs involved in removing PMI as no new appraisal is needed.
We expect to live in the home for the next 1-2 years and then purchase a new home and sell the townhome.
First off, if we look at the mortgage itself, at 5.875% this by itself is not very attractive to me. My second rental property has a 30yr mortgage at 6.5% and would pay down this mortgage first.
However, things get more interesting when we factor in PMI, and that I will be able to get the money back out likely within the next couple of years when we sell the townhome. This means I could potential put the $30,000+ I have saved for our new home into the mortgage and get it out when we are ready to buy the new home.
The current monthly premium for PMI is $45.14**.
Current mortgage balance:$109,922.11
Payment needed to reach 78% of original home value: $19,052.11
Interest Rate: 5.875%
Effective after-tax Interest Rate*: 3.9329%
*After reducing interest rate by tax savings likely realized.
**The PMI on this mortgage is not tax deductible.
So the question is if I made a principal payment of $19,052.11, what would the effective return be after factoring in tax benefits loss?
I would be saving $62.43 per month in interest if I use the 3.9329% effective return, and save $45.14 per month in PMI premiums. This would total $1290.84/yr in returns or a 6.77% after tax, risk free return on my money.
Risk-Free Short Term Investment Options
Pay Down on 2nd Home w/ 6.5% Mortgage*
Mortgage Payoff to Cancel PMI on 3rd Home
While I think the decision to get a mortgage with PMI by my wife was an expensive one, at this point it looks like it we would get a better return on our money by taking $19,052.11 of our home savings from our savings accounts and paying down this mortgage to get rid of PMI.
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