If you don’t know me, my name is Craig Curelop, also known as the FI Guy and author of the book The House Hacking Strategy. In my house hacking endeavors, I get asked a lot of questions, and I hear a lot of excuses. One of the excuses I get the most is, “I do not want to pay private mortgage insurance.”
What Is PMI?
For those who do not know, private mortgage insurance (aka PMI) is a monthly fee added to your mortgage expense when the borrower puts less than 20 percent down on a primary residence. The purpose of PMI is to protect the banks so we do not have a repeat of what happened in 2008, when banks were lending 120 percent loan-to-value to people with no income, no jobs, and no assets.
If you are putting down less than 20 percent, your principal balance is higher, which means your monthly payment is higher, which means there is a higher probability (from the bank’s perspective) that you will not be able to stay on top of your loan. In order to protect them from this, they added primary mortgage insurance.
The cost of PMI varies based on the price of the property you are purchasing. Depending on credit score and your risk profile to the lender, you will pay between 0.5 to 1 percent of the loan amount in PMI per year. Here’s an example.
If you were to purchase a property for $315,000 and put 5 percent down, the total loan amount would be about $300,000. Therefore, the PMI would be $3,000 per year or $250 per month.
In this article, I am going to use this example to compare two types of house hackers’ financial position. Let’s say the first used the low down payment method (pays PMI) and the second put down the traditional 20 percent (and therefore does not pay PMI).
Before we get into the comparisons, I’d like to lay out a few assumptions. All assumptions will remain the same for each example with the exception of PMI and the down payment.
- Initial Savings per Month: $1,000
- Purchase Price of Property: $315,000
- Interest Rate: 4.5%
- PMI: 1% per year or $250 per month
- Insurance: $150
- Taxes: $180
- Appreciation: 3%
House Hacker Who Does Pay PMI
Meet Alex. Alex is excited to get into his first house hack and does not really care about whether he pays PMI or not. He has some money in a savings account but wants an additional $15,000 for the down payment. After 15 months, he has $15,000, which is enough for the down payment on a 5 percent down conventional loan.
For his first deal, he decides to do just that. He purchases a five-bed, three-bathroom single family home for $315,000 with 5 percent down. His monthly payment is $2,100, including PMI of $250 per month.
Alex is able to rent out the other four rooms for $700 per month and collects a total of $2,800 in rent. He sets aside $400 for reserves, and his cash flow is $300 per month. After you factor in his rent savings (his room is worth $700), his true cash flow is $1,000 per month—even with the PMI payment!
Because Alex is a smart individual, he does not elevate his lifestyle. He continues to save $1,000 like he was before AND saves the additional $1,000 from his house hack. His total monthly savings is now $2,000. After living in the home for one year (which is the obligation he made to the bank when using the 5 percent down loan), Alex will have an additional $24,000 saved up and enough to purchase the next house hack.
Because he likes this method, we are going to assume that with each additional house hack, he will gain $1,000 of additional cash flow.
Now let’s visit our friend Kaylee, who does not pay PMI.
House Hacker Who Does NOT Pay PMI
Kaylee is very conservative. She loves the idea of house hacking but is really intimidated by the idea of having an extra $250 per month added to her mortgage payment. To avoid this, she decides to put the normal 20 percent down.
Just like Alex, Kaylee saves $1,000 per month from her job, and she wants to purchase a similar property: a five-bed, three-bathroom house for $315,000 that she can rent out to other people to help pay her mortgage. With 20 percent down, Kaylee will need to pay $63,000 up front to avoid PMI.
Given that she is saving $1,000 per month, she will be able to purchase her first property in 63 months or 5.25 years. When she is able to purchase her first property (assuming the price stays the same), she will have a monthly payment of $1,600 per month. This obviously does not include PMI, and because she put more down, she is paying interest on a lower loan balance.
Kaylee rents the house for the same amount as Alex. She collects $2,800 in rent and lives for free (a value of $700). After setting aside $400 in reserves, she is making $1,500 per month in rent—a great deal!
Similar to Alex, Kaylee does not elevate her lifestyle. She continues to save $1,000 and adds an additional $1,500 from her house. Her total monthly savings is now $2,500. In order to save up for her second house hack, she will need to save $63,000 again. To do that, she will need to wait about 25 months or two years.
The main difference between Alex and Kaylee’s decisions is that Alex’s monthly cash flow on any given property is $500 less than Kaylee’s. However, Kaylee needs to wait over five years to save and purchase her first house hack.
If Alex continues to purchase a house hack of similar stature each year, he will have five properties and $5,000 of monthly cash flow to Kaylee’s $1,500. In year seven, Kaylee will be able to purchase her second property bringing her portfolio to $3,000 of cash flow and Alex will have $7,000.
Starting with her third house hack in year eight, Kaylee will be able to purchase each of her next properties with 20 percent down within a year—just like Alex has been doing. If they both continue to buy one property per year forever at the same trajectory, Kaylee’s monthly cash flow will eclipse Alex’s after year 18.
But who the heck wants to house hack for 18 years?! Not even I want to do that.
This study assumes that Alex only buys one house hack or rental property per year. At year seven and before Kaylee purchases her third house hack, Alex will be saving over $96,000 per year. This mean, he can purchase a house hack AND a traditional rental, increasing his cash flow by $2,500. Meanwhile, Kaylee’s cash flow is still just increasing $1,500 after each property purchase.
Alex will always be able to purchase more properties per year than Kaylee, which means she will never catch up!
Now do you understand why I do not care about PMI? By waiting to put down 20 percent, you are wasting an insane amount of time before you can get your second, third, and fourth property. One property will likely not get you to financial independence. It will take a few. So if you are looking to create the most wealth and achieve financial independence in the least amount of time, house hacking with a low percentage down is clearly the way to go!
What makes house hacking so powerful is the low down payment. I have not seen any other investment type where you can put down 3 to 5 percent (or $15K) and cash flow $1,000-plus per month—not to mention all the other benefits of real estate like appreciation, tax benefits, loan paydown, etc.
If you were on the fence because of PMI, I sure hope this cleared things up for you! Happy investing!
Do you have additional questions for me about PMI or anything above?
Ask me below in the comment section!