Ask the grumpies: Paying PMI vs retirement accounts?

Clueless in the Northeast asks:

New-ish homeowner here who put a bit less than 20% down and thus have to pay around $40/month in PMI. Does it make any sense to prepay your mortgage given incredibly low interest rates? We’ve got stable jobs and don’t think that we will be trying to buy a more expensive house anytime soon. We’re risk averse and not (yet) great at investing (having money to invest is a new experience), though we could bump our retirement contributions higher than the current 15%.

Disclaimer:  We are not personal finance professionals.  Please consult with a personal finance professional or do your own research before making any life-changing decisions.

Generally one wants to have at least 20% equity in case one ends up in one of those scenarios in which housing prices drop and you lose your job and the stock market crashes– you never want to be in a situation in which you have to short-sell your house.  So, for that reason alone it can make sense to pre-pay your mortgage.  (Keeping money in savings also works for this potential problem, but if it’s going to go towards the house, then you might as well get the benefit of not paying interest while you wait.)

Still, you only get so much space for retirement, and if you’re expecting higher salaries in the future, you may some day want to save more than the maximum amount and you will regret not having put money away into a safe retirement space now.  There’s a lot to be said for maxing out retirement savings as soon as you can.  (Though 15% is well within the general recommendation of how much to save each year.)

The only obvious choice here would be if you were missing any employer match (you would want to put more towards retirement), but if you’re contributing 15%, that is very unlikely.  Otherwise, putting money to pay off PMI or putting money in retirement are both good decisions.  One question would be how much money we’re talking about to get to 20% and save $480/year plus whatever you save from the actual pre-payment– if it isn’t that much, then it would make sense to just do that and then you would have $40/month more to send to retirement accounts right away.  If we’re talking tens of thousands, well, you’re only allowed to contribute a certain amount to retirement each year so you could contribute to the max and put the leftover into the mortgage and just keep doing that for years.

We really like the GRS mortgage calculator to see how much money you save with different amounts of pre-payment.  Then you can run through the actual dollar amounts of different scenarios to get an idea of how much money you would save given your current interest rates.  Note that the way mortgages are amortized, you save more money with early prepayments than with later prepayments.

One strategy:  If you’re not contributing to an IRA Roth or a Backdoor IRA Roth that could be one way of mitigating risk– if we have another enormous crash you could tap that to avoid a short-sale on your house (or to keep paying your mortgage).  You are allowed to withdraw contributions but not interest.  If there isn’t an enormous crash, then you could keep the money in retirement until it is time to withdraw many years in the future.

Bottom line:  Both putting money towards the mortgage to get rid of PMI AND putting more money away for tax-advantaged retirement are good ideas.  If it were me:  If I could pay off the PMI in a year or two I would probably make that my priority, otherwise I’d put the extra money into a ROTH IRA knowing that I could tap the principal in an emergency.

Grumpy Nation:  What would you do?  What have you done?

8 Responses to “Ask the grumpies: Paying PMI vs retirement accounts?”

  1. Matthew D Healy Says:

    The following isn’t useful for the question, but one of my longstanding pet peeves about the US mortgage system is that prepayment doesn’t change the due date for the next payment as it does in some other countries. If prepayment meant one then had the option of skipping payments in the future (so long as principal was always at or below the original amortization schedule), then it would become a much more attractive option for many people. Under that system, if one prepaid, say, six months ahead of schedule then in the event of job loss one could skip mortgage payments for six months. Of course this would only apply to P&I, the Escrow for taxes wouldn’t go away…

    • nicoleandmaggie Says:

      I’ve seen some people complaining about their banks putting prepayment money towards future payments instead of towards principal… which isn’t what you want when you’re prepaying! (Since you still have to pay interest on that money.)

      • omdg Says:

        Our bank did that when we prepaid a few years ago, which was incredibly obnoxious. Husband called and asked them to apply the additional payments to principal instead, which they complied with. You really have to watch them because they will take advantage. Also when you get your mortgage make sure there is language specifying NO PREPAYMENT PENALTY.

      • Lisa Says:

        +1 on the NO PREPAYMENT PENALTY, but I’ll note that we once got a mortgage where the agent warned us about the prepayment penalty, and it was something like $50. So in that case, I wasn’t too worried about it. But be sure to check!

  2. revanche @ a gai shan life Says:

    We had an enormous mortgage so even though PMI was not an issue, the size of the mortgage was when I considered the risk of being upside down on it in the event we had to get out of here for other reasons. I reason that if we were in a position where we’d NEED to sell, it’d be likely that other things had gone wrong too so I wanted to minimize the future impact of a quick sale on our finances. I also wanted to reduce the interest we’d pay over the lifetime of the mortgage.

    In retrospect, an argument could be made that I’d have done much better by the family finances if I’d plowed all that cash into a brokerage in the past four years. If it was purely about numbers, I did the wrong thing. But I also wouldn’t have had the same peace of mind as we did during the pandemic, and we might not have been willing to risk PiC’s job change during the whole thing which was important for our sanity.

  3. Jenny F. Scientist Says:

    One of our employment perks is that we don’t have to pay PMI (because they take mortgage payments out of your paycheck, the university owns about half my house). We paid it on our last house because we were too poor to do otherwise.

  4. First Gen American Says:

    We didn’t buy til we had 20% so I am in the mortgage camp.

    If you consider yourself conservative, pick the sure thing. You’ll sleep better at night. I may have had another opinion if you weren’t already saving 15% but that base seems decently covered.

    If you are okay taking risk, how would you feel if that money lost the 50% returns that the latest rally just yielded. Some people are fine with it some people kick themselves. either way saving more is a good thing so the small difference in performance may not matter in the long term.

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