The Basics Of A 80 20 Home Loan
80-20 home loans – also known as a "piggyback" or no PMI loans – occurs when the borrower takes out two loans, one for 80% of the purchase price of the home, the other for 20%. The borrower is usually responsible for paying closing costs and certain other fees, but the 80/20 structure allows for little to no down-payment and avoids the cost of mortgage insurance. An 80 20 interest only mortgage is not uncommon for borrowers who are trying to get into a mortgage with the least amount out of their pockets.
Why Get an 80-20 Loan?
Most people who choose this home mortgage loan do so because they can afford a monthly mortgage payment but have difficulty saving money towards a down-payment. Such people find themselves stuck renting when they really want to buy. Alternatively, some people choose the 80-20 option because, though they have the money for a down-payment, that money is invested or otherwise tied-up, and they'd rather not use it.
While other loan types might allow borrowers to take out a mortgage without a down-payment, lenders usually require PMI (Private Mortgage Insurance) when homebuyers borrow more than 80% of the purchase price. PMI protects lenders from losing money on a foreclosure should the borrower fail to meet the monthly payments. While PMI protects lenders, for borrowers it can be very costly. That's where an 80-20 loan comes in.
How Does an 80-20 Loan Work?
To borrow the cost of a home without making a significant down-payment or having to purchase PMI, homebuyers can take out a first loan for 80% of the purchase price, and then take out a second, or "piggyback," loan for the remaining 20%. Some borrowers choose to make a small down-payment, resulting in configurations like 80-10-10 or 80-15-5 (1st loan-2nd loan-down-payment). Many combinations are possible, as long as the first mortgage loan doesn't exceed 80% of the purchase price.
Usually, the second mortgage loan carries a higher interest rate than the first loan. However, the total cost of the piggyback loan is often less than a PMI loan (a single loan + mortgage insurance). As an added bonus, mortgage interest payments are tax deductible, while mortgage insurance payments are not. To determine whether an 80-20 loan is advantageous, borrowers need only compare the total 80-20 loan rate with the cost of a single loan rate and mortgage insurance.
The 80-20 loan can be set up in many different ways, depending on the lender's and borrower's wishes. One common structure is a 5/1 Adjustable Rate Mortgage for the primary loan (meaning that the loan has a fixed rate for the first five years, then adjusts annually after that) and a home equity line of credit attached to the prime rate for the second loan. Such loans are designed to be refinanced every 3-5 years, so borrowers who find their circumstances improved can tweak the loans to their advantage.
Is an 80-20 Home Loan a Good Idea?
As with all loans (particularly non-traditional loans), 80-20 loans have their advantages and disadvantages.
On the plus side, 80-20 loans allow borrowers to take out a mortgage with little to no down-payment, while avoiding the cost of mortgage insurance. Therefore, as long as they can afford the closing costs on a loan, buyers can borrow the purchase price of their new home. Furthermore, if borrowers take advantage of interest-only features offered in conjunction with 80-20 loans, monthly payments can be kept as low as possible.
However, 80-20 combo loans can be a disadvantage if the house loses value (a particular danger in inflated housing markets). When this happens, borrowers find themselves owing more than the house is worth; and if such borrowers have an interest-only mortgage, the situation can continue for a very long time. If the value of the house declines more rapidly than the loans can be paid off, 80-20 borrowers might be faced with having to repay the loan in full should they want to sell or refinance the house.
Therefore, borrowers should consider their prospects and market predictions carefully before signing up for an 80-20 mortgage loan. However, for cash-strapped borrowers who want to start paying a mortgage and stop paying rent, and even for borrowers with plenty of money who would rather leave invested money where it is, the 80-20 home loan can be a great solution.