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PMI's Effective Rate

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THE SCENARIO Primary Mortgage Insurance, or PMI, is a type of insurance that makes it more expensive to buy a house if you don't have a big enough down payment. Even if you get a really good rate on your mortgage, PMI can increase the effective rate to the point where maybe it's not so great anymore. The question: If I borrow $365,000 to buy a house with a 30-year, fully amortizing mortgage at 3.5% interest (this rate was available in the 2012 - 2013 time frame), and PMI increases my payment by $300 per month, what's my effective rate* on my mortgage? * Here, I'm only talking 'effective rate' in terms of the payment I have to make each month, not the rate of amortization, which is faster in the early years when the rate is lower.

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THE SOLUTION This one has two parts.

1. Figure out my payment without PMI
2. Figure out the effective interest rate once PMI is added in

First things first, make sure the calculator is using 12 Payments per Year. Step 1: What's my payment? N: 360 (It's a 30-year mortgage) I/YR: 3.5 (The rate is 3.5%) PV: 365,000 (I borrowed $365,000) PMT: (This is what I'm trying to find) FV: 0 (It amortizes fully)

The monthly payment on my mortgage without PMI is $1,639.01.

Step 2: What's my effective rate? N: 360 (It's a 30-year mortgage) I/YR: (This is what I'm trying to find) PV: 365,000 (I borrowed $365,000) PMT: -1,939.01 (This is my $300 PMI payment added to my $1,639.01 mortgage payment) FV: 0 (It amortizes fully)

The increased payment due to PMI brings my effective interest rate up to 4.91%, nearly one and a half percentage points higher than the rate my bank is charging me.

I'm not a fan of PMI for many reasons, and this is one of them - it makes your mortgage more expensive, which means that it's more likely that you'll default on the payments, which is the exact thing PMI is supposed to insure against. Sometimes, though, accepting PMI is the only way to get a mortgage - saving up a huge down payment is time-consuming and difficult, and during the time you're doing it, you'll still want to have a place to live. So paying PMI can be considered to be a necessary evil, unavoidable as it sometimes is.

What do you think? Would you bite the bullet and get the loan with PMI attached in order to get into a house? Or would you tough it out as a renter for several more years until you've pulled together enough for a big enough down payment that you wouldn't have to pay PMI? Or would you choose a third option? Let us know in the comments!