Many home buyers believe they need to put 20 percent down for a house. However, many home buyers end up putting down less than 20 percent. In fact, an analysis done last year by RealtyTrac showed that the average buyer made a 14 percent downpayment.
Some downpayments are even lower than 14 percent. FHA loans require a downpayment of just 3.5%, and conventional loans can go as low as just 3% down.However, making a downpayment of less than 20 percent requires private mortgage insurance (PMI).
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PMI can add quite a hefty monthly expense – sometimes hundreds of dollars — to your monthly mortgage payment.
There is an option some borrowers are choosing to avoid a downpayment of 20 percent or more while also avoiding PMI. This mortgage is often referred to as a piggyback loan, or sometimes as an 80-10-10 loan..
If you are planning on putting down between 5-15 percent on your house, you can take out two loans for the rest of the purchase price of your home so you can avoid the PMI. The first loan is bigger and is usually a traditional loan with a fixed rate and an 80 percent loan-to-value ratio (LTV).
The second loan is a home equity loan or home equity line of credit (HELOC), which you sign off on at the same time you get your main mortgage. This loan makes us 5-15 percent of your downpayment. So, if you want to make a downpayment of 10 percent, you second loan would be for 10 percent of your home’s value.
Typically, the main mortgage usually has a lower interest rate while the second mortgage has an adjustable rate
Piggyback loans have been gaining in popularity over the past few years, making up over 3 percent of all originated loans.Piggyback loans are even more popular among first time home buyers who can’t afford a 20 percent downpayment.But before signing up for a piggyback loan, understand the pros and cons.
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The Pros And Cons
Pro – You avoid PMI. This is one of the main reasons home buyers will opt for a piggyback loan over other options. PMI, or similar types of mortgage insurance, are required for other popular mortgage options that don’t require a 20 percent downpayment.
Pro – Current mortgage rates are near record-low levels. Waiting to save up for a larger downpayment could mean missing out on today’s low rates.Con — With home equity lines of credit, the rates are usually variable with no fixed payment schedule. Your rates could increase and you could end up with a higher monthly payment.
Pro – These loans can be used to avoid getting a jumbo loan, which can be costly.
Con – The cost of the second mortgage could be much higher than the first mortgage because of the interest rate. Lenders take a bigger risk on the second mortgage , so it can be reflected in the cost.
Pro – This type of loan allows you to spend less of your own money at the closing. Even if you have the money for a 20 percent down payment, it’s always nice to have some set aside for emergencies and home improvement.
Pro – Interest paid on a piggyback loan is tax deductible.
Pro – If you know you won’t be staying in a certain area for a long time, this loan might be the way to go since you will be selling the house before your second mortgage’s interest rate goes up.
Con – Taking out that second loan just might limit your borrowing capacity against your home in the future.
Con — Similar to your first mortgage, second mortgages will require closing costs.
Con – You’ll have two mortgage payments per month,and it could total to more than the costs added by PMI.
Check Your Eligibility
Before taking out a piggyback mortgage, make sure you have all the facts. Compare the costs of such a loan compared to paying the PMI or getting a lender paid mortgage insurance. Ask a lot of questions from your lender and get a clear picture of what it all means to your budget and your future equity.