It is no surprise that coming up with a 20 percent down payment for the purchase of any home can be a challenge even for the most steadfast of savers. But are there loan programs for those with less than a 20 percent down payment? The answer is “yes!” In fact, there are two common ways we’ll see a buyer attempt to purchase real estate when there is less than a 20 percent down payment. They are:
- A piggyback mortgage structure. This is also known as an “80-10-10” loan. The buyer will finance up to 80 percent of the purchase price on a first mortgage, and then use a smaller, second mortgage (aptly referred to as “secondary financing”) for the additional 10 percent. The balance is the buyer’s down payment. Both loans are often arranged by the same loan originator/lender and via the same application and loan approval process.
- PMI. PMI stands for private mortgage insurance. Buyers with less than 20 percent down (and who cannot or choose not to use a piggyback loan) will need to pay an insurance premium as part of their mortgage payment. This insurance offsets the lender’s increased risk in making a loan with a lesser amount of owner’s equity. The premium varies in relation to the loan-to-value (LTV) with higher LTV’s resulting in higher premiums.
The key points below outline some of the things to consider when weighing the choice between an 80-10-10 and PMI.
- assess your own profile
- consider all the options
- weigh the pros and cons carefully
- ask your lender for clarification on the terms of both loans
- misunderstand 80-10-10 — it doesn’t have to be literal
- assume a lower monthly housing payment is without consequence
- expect 100% financing or 0% down payment
- forget to consult your tax professional
Buying a home is a serious undertaking, whether it’s your first purchase or not. Regardless, it’s important to carefully review your current financial resources and requirements before looking into any mortgage option. Have you carefully considered how your housing payment will fit into your budget? Do you know how much of your savings you can apply towards the down payment without feeling strapped? These are elements you can and should control before rushing too far into the homebuying process.
Even if you’ve been led to believe that a piggyback loan is better for you than PMI, be sure to at least consider PMI in your review. Remember that conventional wisdom may not dovetail with your individual goals, and if it doesn’t you should still stick with what’s best for you. Sometimes it’s okay to go against the crowd.
As with many choices in complex financial situations, all are imbued with both pros and cons. Rarely is any one solution perfect. Because of this, be sure to view your home loan options from the perspective of not only dollars and cents, but also from the perspective of time. It may reveal that 80-10-10 financing works great if you end up holding the home for up to five years but that this solution gets progressively less attractive the longer you keep the home thereafter. The pros of the lower payment might be offset by the “cons” of interest rate risk over time.
Just because you’re opting to get a piggyback structure for your home purchase or refinance doesn’t mean that you should let the second mortgage play second fiddle. A good mortgage professional will take the time to explain how the junior mortgage works too and it’s important you understand this just as if it were the main loan. Making the timely payment on both loans carries equal weight from the consumer’s perspective.
Piggyback financing is a concept. It’s a means to an end. Even though an 80-10-10 structure is the most common (this means an 80 percent first mortgage, a 10 percent second mortgage and a 10 percent down payment), the reason piggyback financing is ultimately used is to avoid another type of loan structure that may be less beneficial. So, it’s possible to also get a 75-15-10 or an 80-5-15 (15 percent down payment in this last case) as the situation may dictate. This can get complex, but realize that just because people commonly refer to all piggyback loans as 80-10-10’s doesn’t mean they actually all are.
Often when comparing a 10 percent down payment scenario with a piggyback mortgage on one hand and PMI on the other, the piggyback will win from a monthly payment standpoint. However, that could be because the piggyback mortgage itself has an interest-only payment. It could also be because the second mortgage has an adjustable rate that could, over time, go higher. Or, in the case of a home equity line of credit, or HELOC, it could be both.
Currently (2014), most piggyback loans will not permit down payments quite as low as PMI. If you are planning to make only a 5 percent down payment, for example, PMI may be your only option. Years ago, it was possible to use an “80/20” structure, and here, a borrower would have a 0 percent down payment and put 80% of the purchase price on the first mortgage and borrow the other 20% on the second loan. Those programs, by and large, are no longer available.
One of the biggest selling points for secondary financing is the tax-deductibility of the mortgage interest. Before you assume that you’ll gain that year-end benefit, do consult with your tax advisor to get a better understanding of the rules and limitations of the mortgage financing you plan to put in place. In fact, this is a good idea no matter what mortgage program you’re contemplating.
Choosing the mortgage structure that is best for you in the very common situation where less than a 20 percent down payment is requires an understanding of both your needs and the lender’s requirements. It’s not possible to focus on one or the other and make an informed and responsible decision as a future homebuyer. By keeping in mind the points above and asking questions of your mortgage and finance professionals as they develop, you can determine which is the best fit. There is no universal right or wrong when it comes to “piggyback vs. PMI” and either approach, in the right hands, can provide a wonderful opportunity for home ownership with less than a 20 percent down payment.