I would like to understand whether it is better to make extra payments on a home loan that includes PMI (Private Mortgage Insurance) or a different (high interest) loan.
Typically, when deciding between paying off one loan or paying off another, I would choose the loan with a higher interest rate. However, PMI complicates this calculation. Once one reduces a home loan's balance to 78% LTV, the PMI must be cancelled by the lender. (It can be cancelled earlier in some cases, such as at 80% LTV.) I'm not sure how to reason about what this does to the loan's interest rate.
I've included an example below, since it seems like an explanation would be easier with real numbers.
Loan 1. Home loan
- Home value: $100,000
- Loan balance: $90,000
- Interest rate: 2%
- PMI rate: 1%
- Lender will drop PMI when loan reaches 80% LTV
Loan 2. Unsecured loan
- Loan balance: $5000
- Interest rate: 10%
How do I reason about which loan to make extra payments on?