If you buy a house with less than 20% down or if you haven’t built up at least 20% equity before mortgage refinancing, you’ll typically have to pay private mortgage insurance (PMI). This protects the lender in case you default on the mortgage loan.
The U.S. Public Interest Group in Washington and other consumer-advocacy groups have been pressuring Congress to enact legislation that would require lenders to stop billing for PMI automatically once a borrower achieves about 20% equity. Right now, the consumer generally has to ask a lender to stop charging for PMI, which is not easy to do. “I have heard of lenders who won’t cancel PMI, regardless,” says Keith Gumbinger, vice president of HSH Associates, a mortgage-information provider in Butler, N.J. This is one of the main reasons why a growing number of buyers are avoiding PMI altogether by getting what’s known as a “piggyback mortgage.” “A piggyback mortgage is a second mortgage that closes simultaneously with the first,” explains Chris Larson, chief executive officer with E-Loan, an online provider of consumer loans based in Dublin, Calif.
A piggyback mortgage is also known as an 80-10-10 loan because it involves a first mortgage for 80% of the purchase generally offered at a lower rate, a second trust loan (second mortgage) for 10% at a slightly higher rate and the remaining 10% as a down payment. But variations, such as 75%-15%-10%, are also available.
“This can significantly reduce a borrower’s monthly payments,” says Mark Smith, president of the Mortgage Bankers Association of America in Washington and chief executive officer of Crestar Mortgage Corp., a unit of Crestar Financial Corp., Richmond, Va. “And the interest on the second mortgage is tax-deductible–PMI payments are not.” For areas where housing is more expensive, buyers find that the piggyback mortgages can help them keep their primary mortgages below the conforming limits set annually by Fannie Mae and Freddie Mac, the agencies that dominate the secondary market in mortgages. Currently, 30-year fixed rate home mortgages that exceed $417,000 are considered “jumbo” (non-conforming) mortgages, which carry higher interest rates.
Piggyback mortgages are also flexible. You can either take it out as a home equity installment loan (HEIL) where you get a lump sum all at once or as a home equity line of credit (HELOC) where you can pay off the line of credit and draw down on it and use the funds for other purposes without having to apply for another loan. And, of course, you can refinance both loans when your home appreciates in value and possibly pay a lower rate of interest, making your savings even greater.