Mortgage loan with PMI or a piggyback loan
Private mortgage insurance is required when you purchase a home
with a down payment of less than 20% of the sale price or the
appraised home value, whichever is less. Your lender in this
case will expect you to purchase a private mortgage insurance
policy so that even if you default, he can compensate for the
loss. So when you make low down payment on your home purchase,
you pay for the insurance premiums on a monthly basis till you
can build up sufficient equity in your home. You can avoid PMI
premiums if you are approved for a piggyback mortgage loan.
These loans involve 2 mortgages combined in the ratio of 80/20,
80/15/5 or 80/10/10. This implies that you take a first mortgage
against 80% of your home value and second mortgage against the
remaining 20% the property value.
Otherwise, you can opt for a first mortgage against 80% of the
property value with a second mortgage worth 15% and make a down
payment of 5% on the sale price. The third option is that you
make a 10% down payment on the sale price and then go for a
first mortgage of 80% along with a second mortgage loan against
10% property value.
But the question remains as to which is the best option -
whether you go for a home loan with a PMI or you look for a
piggyback mortgage.
With a mortgage loan requiring PMI premiums, you don't get the
advantage of tax deduction, as these premiums are not
deductible. But for a piggyback loan, the interest payments on
both the mortgages are tax deductible. Thus, you get the
opportunity to make savings. But then with this kind of a
mortgage, you are required to pay off the second loan at a
higher rate of interest compared to the first. This is because
if you default, the second mortgage has to be paid back after
you repay the first. So lenders consider it a big risk to offer
a second mortgage in such situations.
But in case you go for a mortgage with a PMI and home values go
higher, you can build up equity faster and this will help you to
get rid off insurance premiums in a shorter time than when the
home prices are stable. Moreover, the monthly premiums decline
when you are closer to building up 80% of your home equity. Even
if these do not work in your favor, you can go for a lender-paid
mortgage insurance or LPMI policy which allows for a rollover of
the PMI costs into the mortgage itself. But most experts don't
approve of this policy as the payments are amortized throughout
the loan term.
On the other hand, if you go for piggyback mortgage, it will
help you to avail a larger loan amount and at the same time give
you the opportunity to keep the primary mortgage below the
conforming loan limit. You can avail the difference in the loan
amount and the conforming limit from the second mortgage and
this will prevent you from paying higher interest on the primary
mortgage which is well below the conforming limit.
Apart from this, you can avail the second
mortgage as a home equity line of credit. Once you pay off
the line of credit, you can again withdraw cash from it till the
loan period is over. But after taking 2 mortgages, most lenders
will not approve you for an additional loan against your home
equity. In addition, it is easier to qualify for a traditional
mortgage with a PMI rather than with a piggyback loan. Lenders
often demand a FICO score of 680 for the second loan and about
620 for the first mortgage and most borrowers fail to build up
such scores.
Furthermore, some lenders may accept interest only payments on
the second loan for a period of 10 to 15 years and then require
you to pay the dues with balloon payments. Borrowers accepting
such options often fail to make huge payments and end up
refinancing the second loan, that too when market rates are
high. But a loan with a PMI can help avoid such situations.
Considering the pros and cons of a piggyback mortgage, it is
advisable that you choose a traditional mortgage loan along with
the payments for private mortgage insurance. The premiums may
not be tax deductible but it is better to pay those premiums
rather than make interest payments on 2 mortgages and that too
when the rate charged on the second loan is quite higher. The
second loan in a piggyback mortgage is usually a variable rate
loan; so in order to avoid higher interest rates, borrowers
should preferably opt for a mortgage loan that requires PMI
instead of a piggyback loan.