Use PMI as a wealth-building tool

Homeownership is the primary means of wealth building in the U.S.

Owning a home is no path to quick riches. Rather, it’s an investment that pays off over time, even considering cyclical downturns.

Long-term housing data supports this fact.

According to the government lending agency FHFA, home values are up more than 140% since 1991. That means a home worth $100,000 in January 1991 is worth $240,000 today.

Over that time, inflation has risen 75%, says the Bureau of Labor Statistics. A first-time home buyer in 1991 has beat inflation, plus made an additional sixty-five percent return on investment.

Inflation-adjusted return is a tangible way to look at wealth increases, but there are non-tangibles, too.

For instance, a homeowner who purchased a home in 1991 is likely near the end of its 30-year fixed mortgage. Soon, the homeowner will be mortgage-free. Cost of living will drop.

The owner holds a considerable asset, too.

Yet, a person who chose to rent in 1991, and continued to do so, now pays ever-increasing rental prices.

Worse, it’s likely this person has no sizeable asset unless he or she has contributed to a retirement account or other investment consistently over two or three decades. Many have not been this forward-thinking.

A house is a forced savings account. Housing expenses are required whether you rent or own. But when you own, you deposit a small chunk toward future wealth.

So what does PMI have to do with this? It starts the wealth-building process sooner. You can be on the winning side of rising home values.

And, without PMI, you may be unable to save fast enough to catch up with home prices.

Securing a home at today’s prices is a solid advantage. But there’s another one: PMI is an investment with a return like few others.

PMI return on investment

Home buyers avoid PMI because they feel it’s a waste of money.

In fact, some forego buying a home because they don’t want to pay it.

That could be a mistake. Data from the housing market indicates that PMI yields a surprising return on investment.

According to FHFA’s House Price Index, home prices are up 3.5% per year since 1991.

Home price acceleration has been higher of late — well past 5%. However, taking a longer view provides a more balanced, realistic view of the housing market — and what you might “earn” per year as a homeowner over the long run.

Keep in mind that the three-and-a-half percent gain factors in the housing downturn of the last decade. That percentage is derived by looking only at a “rosy” period of market history.

The average home costs $233,000, per National Association of REALTORS data. The following is an example of a buyer who purchases the “average” home with and without PMI.

First, assume the buyer puts 5% down.

The PMI cost is $135 per month according to mortgage insurance provider MGIC. But it’s not permanent. It drops off after five years due to increasing home value and decreasing loan principal.

You can cancel mortgage insurance on a conventional loan when you reach 78% loan-to-value.

The homeowner’s snapshot at the end of year 5 looks like this:

• Current value: $276,000
• Principal remaining: $200,000

In five years, the home has appreciated $43,000, and the final PMI cost is $8,100. That’s a 5-year return on investment of 530%.

It’s near impossible to make that kind of return in the stock market, retirement account, or another financial instrument.

PMI, then, can be viewed as an investment — a very sound one — and not a waste of money.

But that may not be where PMI’s benefits end. There is another factor when postponing a home purchase to avoid PMI: opportunity cost.

What it costs to avoid PMI

Assume a different homebuyer followed “best practices” as posited by many financial and housing advisors today.

The buyer chose to avoid PMI. Instead, he or she opts for a 20% downpayment: fifteen percent more than the buyer who chose PMI.

The buyer has some saving to do.

He or she budgets and plans to accumulate $10,000 per year toward the goal — difficult but doable. In three and a half years, the buyer raises the full 20% downpayment.

But not quite.

He or she is now chasing higher home prices. In 3.5 years, home prices will have risen nearly thirteen percent — factoring in compound interest — or around $30,000.

The buyer no longer needs 20% down based on home prices of three years ago. He or she needs twenty percent of the home price.

That’s an additional six thousand dollars.

The increase pushes out the buyer’s time frame. He or she must save four years to put twenty percent down. During that time, the home buyer forfeits $34,000 in lost home equity.

Add up lost equity and extra downpayment costs, and waiting to buy has cost this buyer thirty-two thousand dollars — even after considering the PMI expense he or she “avoided”.

There are many good reasons to delay buying a house. Skipping PMI is not one of them.

PMI with direct-to-buyer benefits

PMI benefits the buyer indirectly, but some mortgage insurance companies now offer buyers direct value, too.

One PMI provider, Radian, layers its MortgageAssureSM product on top of its standard PMI coverage. This program offers job loss protection for the buyer.

The insurance covers the borrower’s payments — up to $1,500 per month for six months — in the case of a job loss during the first two years of the loan.

The program comes at no additional cost for home buyers who make a down payment between 3-5% on some loan programs.

This is peace of mind for the homebuyer and a very good reason to check which PMI providers your lender works with.

Mortgage lenders often work with three to five PMI providers. Most often, the lender will choose your provider for you. The choice is often arbitrary or based on who the lender is accustomed to using.

But the borrower can have a say in the matter. If you know of a PMI provider that offers a certain benefit, don’t be afraid to ask for it.

The small request could end up making a big difference later on.

How do I know if PMI is right for me?

Private mortgage insurance isn’t for everyone, but home buyers should check potential returns before they automatically refuse it.

Get a home buyer eligibility check, which includes a mortgage insurance analysis for your situation, and comes with no obligation. It takes just minutes to start.