Hi, all,

First post here! I've been binge-reading the blog and really researching investing and saving after having ignored it for the first 9 or so years of my professional career. Luckily, I have very good income now and will just work extra hard to getting to that sweet spot of financial freedom over the next 15 years or so.

Anyway, in regards to mortgage, I see a lot of folks just using the interest rate of the loan rather than APR when calculating how much their income would be worth once they are mortgage free. Which should we be using?

I ask, because in late 2016, I took a 30-year fixed rate mortgage in the US with only 3.5% down. My interest rate is 3.625%, but once you add in the costs and my MIP, which will always be a part of the loan since I was under 90% LTV when I took the loan, my APR comes out to 4.716%.

I could refinance to a conventional loan now to get rid of the MIP (around 0.85%), but interest rates have risen to the point that it probably doesn't make sense.

So, should I look at my potential mortgage-free income (assuming I prioritize paying it down) at having an effective interest rate of 3.625% or 4.716%?

Sorry if this is a dumb question, but all of this is still rather new to me.

Hi and welcome! I'm not sure APR is the right term for interest rate + MIP, but I understand what you're asking. You should definitely be including MIP in your calculations and comparisons. There are several other people with similar questions earlier in this thread (if you dare dig through 15 pages to find them).

The way to do this calculation is to look at how much you save by getting rid of MIP and divide it by how much it takes to get rid of MIP to calculate the return on investment of just this partial mortgage paydown. You also need to be sure that the terms of your MIP allow it to go away just by getting your LTV low enough. Some mortgages, like relatively recent FHA loans, require refinancing to get rid of PMI. This calculation may also change as you get closer to the drop point, so you may want to rerun it periodically to see if it makes sense to make a single principal payment to knock it out.

Here's an example of the calculation, since you didn't provide your specific numbers:

$100k value

$90k mortgage

$81.83/month MIP removed automatically at $78k

$12k required to remove MIP which will save $981.96/year = 8.18% return on investment

edit: you could also add your mortgage interest rate to that return on investment, depending on what you're trying to calculate

Thanks for the quick reply!

With my current terms, being an FHA mortgage from 2016 with less than 90% LTV, the mortgage insurance premiums are a fixed ~0.85% for the life the loan, but it is only re-calculated once per year based on the remaining loan amount at that time. I don't have the math skills to quickly figure out how that would work, but if I combine the 0.85% with the 3.625% interest, I get 4.475%.

I have around $470,000 remaining on the loan, but I am in a position to go full bore and put in an extra $50,000 per year (or around $4166 per month) towards the principal. According to a calculator on my loan handlers site, if I started doing that next month and continued it each month, I would be paid off by August 2025 (7 years) for a total of $470,446 principal and $62,281 interest for $532,727 total. At 4.475%, that would be $556,566, whereas if I invested it assuming a 7% return, I would be at $570,017 or a difference of $13,451. This is all assuming that I would continue to put in 10% or more in my pre-tax 401k and max out my Roth IRA every year.

Assuming my calculations are correct, that's a pretty tough choice. I would be effectively paying $13,451 for peace of mind and a good chunk of equity in rapidly appreciating Seattle-area real estate (who knows how long that will continue, though). On the other hand, I wouldn't have nearly $600k in investments that could easily pay for a lifestyle should I decide to sell the property at that point and downsize to something less expensive (although there's no telling where the Seattle real estate market will be then).

Got some thinking to do for sure.