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When buying a house, lenders typically require that you either make a 20% down payment, or carry private mortgage insurance (PMI). Obviously, you don’t want to incur unnecessary expenses, such as PMI, but it’s not always possible to come up with the cash for a 20% down payment. If you can’t arrange for a gift from a family member to make up the shortfall, but are still determined to avoid PMI, then you might want to consider taking on a piggyback mortgage.
In general terms, this entails making a smaller down payment (say 10% or even 5%) and then borrowing against the downpayment to make up the difference (an additional 10% or 15%) to get to the full 20% mark. This then allows you to take out a standard 80% first mortgage, and avoid the PMI entirely. In other words, you might have an 80% first mortgage, a 10% second (piggyback) mortgage, and 10% down payment (in the case of an 80/10/10 mortgage), or an 80% first mortgage, a 15% second (piggyback) mortgage, and a 5% down payment (in the case of an 80/15/5 mortgage).
A couple of things… Yes, you’ll be responsible for two mortgage payments (the 80% first mortgage as well as the smaller second mortgage). And because the second mortgage is subordinate to the first (i.e., the lender backing the first mortgage is first in line when it comes to collecting what’s owed them in the case of a default), the rate is typically somewhat higher. But there are some advantages to doing it this way. First and foremost, some (initially small) fraction of the payment on your second mortgage will go toward equity (unless you’re doing an interest only loan), whereas PMI payments just go out the window. Second, the interest payments on your second mortgage payment (like those on your first mortgage) are tax deductible, whereas PMI is not.
As far as second mortgage options go, you can take either a standard home equity loan, wherein you agree to pay it back over a fixed period of time, or you can use a home equity line of credit (HELOC), which provides you with the flexibility of putting the money in and taking it back at more or less at will. In our case, we started with a 80/10/10 with a standard home equity loan that was amortized over thirty years, but due in ten years (i.e., we would’ve either had to make a balloon payment or refinance at the ten year mark). When we later refinanced our first mortgage to get a more favorable rate, we also refinanced the second mortgage into a HELOC from our local bank. The interest rate on a HELOC is pegged to the prime rate (+/- a small amount) so it floats. However, the rates were so good at the time that we came out way ahead by floating this portion until we killed it off.
For more information on moving, check out my Roadmap for a Successful Relocation.
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