Low Down Payment? Here Are Two Solutions
If you are paying less than 20 percent down for your new home, you will probably be required to pay private mortgage insurance. Alternatively, you can take out a piggyback loan to make up the 20 percent down payment. Here are the pros and cons of each.
Private mortgage insurance (PMI)
This insurance protects the lender from the risk that you might default on your mortgage and not pay back the money you borrowed. Because you have a lower down payment, the lender considers you to be at a higher risk for default. Annual premiums are typically one half of one percent of the loan amount, and are usually paid monthly as a part of your mortgage payment.
Piggyback loans
Sometimes called combination loans, these are often marketed by lenders as a way of avoiding PMI. They work like this: Let’s say you have the cash for a ten percent down payment. Your first mortgage will be for 80 percent of the value of the home; the piggyback loan (or second mortgage) will be for the other ten percent. The combined payment on both loans may be less than the cost of the single mortgage plus PMI. And, since the piggyback loan is a type of mortgage, the interest you pay may be tax-deductible.
Which is better?
As with most financial decisions, the answer is, “It depends.” It’s a good idea to run the numbers. For example, let’s say you’re buying a $200,000 house and are going to make a ten percent down payment ($20,000). You go with a 30-year fixed rate mortgage at 6.3 percent:
90% Mortgage + PMI
Mortgage Amount: $180,000
Monthly PMI Premium (0.5% of the mortgage divided by 12 months): $75
Mortgage Payment: $1,114.15
Total Monthly Payment: $1,189.15
80% Mortgage + 10% Piggyback
Mortgage Amount: $160,000
Piggyback Amount: $20,000
Mortgage Payment: $990.36
Piggyback Payment (8.0% interest rate / 30 year term): $146.75
Total Monthly Payment: $1,137.11
In this case, the piggyback option will save you $52.04 dollars a month. But even a small change in interest rates can change the equation, so have your lender calculate your particular options. And piggyback loans can sometimes come with their own fees, so be sure and ask your lender about upfront costs for this option as well.
On a final note, keep in mind that you can avoid the charges associated with a piggyback loan and with PMI if you can save enough for a 20 percent down payment. Having a 20 percent or larger down payment can also make it easier to get approved for a loan at a competitive interest rate.
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