When a buyer puts 10 percent or less cash down, most lenders require mortgage insurance, known as PMI, which is paid for by the buyer. The cost of PMI is about 1/2 percent of the loan amount annually. So, on a $250,000 mortgage, PMI will run about $1,250 per year.
PMI provides protection for the lender in case the buyer stops making mortgage payments. Buyers don’t like PMI because it increases the cost of home ownership. Currently, unlike most mortgage interest paid on a primary residence, PMI is not tax deductible.
Low-cash-down buyers can avoid PMI by using piggyback financing. Here’s how it works. Let’s say you have enough cash to put 10 percent down on the purchase of a new home. If you borrow a mortgage for 90 percent of the purchase price, the lender will likely charge you for PMI.
Instead of taking out one mortgage, you combine two mortgages to come up with 90 percent financing and thereby avoid PMI. You could combine a 75 percent first mortgage with a 15 percent second mortgage. Or, you might combine a 70 percent first with a 20 percent second mortgage. You could save as much as $100 to $150 per month using piggyback financing, depending on the size of the loans involved.
You might wonder why anyone would choose to do financing that requires PMI. For some buyers, there’s no other choice. Piggyback financing requires good credit. Second-mortgage lenders can be stricter than first-mortgage lenders in their qualifying criteria. Typically, borrowers need a credit score of 660 or more to qualify.
Recently, piggyback financing has increased in popularity, even with buyers who have a substantial cash down payment. Many large cash down buyers are electing to establish an equity line second mortgage in order to have access to cash on a moment’s notice. There’s often no charge for initiating the loan. The annual fee should run around $75. You’re only charged interest when you write a check against the credit line. The interest rate is often tied to the Prime Rate. And you can usually make interest only payments for up to 10 years.
HOUSE HUNTING TIP: Piggyback financing can be used effectively as interim or bridge financing if you buy a new home before you’ve sold the old one. Recently a trade-up buyer had enough cash to put 15 percent down on her new home. For the long term, she wanted to have a first mortgage of no more than 60 percent of the purchase price. She borrowed a 25 percent equity line second mortgage to make up the difference.
During the period of time that she owned two homes, she made interest only payments on the equity line in order to keep her carrying costs down. When her old home sold, she paid the equity line on her new home down to a zero balance. However, she didn’t close out the equity line. She retained it in case of an emergency. Note that some equity lines do charge an early closure fee during the first few years of the loan. However, if you pay the equity line to a zero balance, but don’t close it, there shouldn’t be a closure fee.
As long as you qualify, you can borrow up to $500,000 on an equity line second mortgage. And, you can use piggyback financing to finance up to 95 or 100 percent of the purchase price.
THE CLOSING: By using an equity line second mortgage for your piggyback financing, you can achieve a lower blended mortgage rate because the interest rate on an equity line is often substantially lower than it would be on a conventional mortgage.
Dian Hymer is author of “House Hunting, The Take-Along Workbook for Home Buyers” and “Starting Out, The Complete Home Buyer’s Guide,” Chronicle Books.
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