One of the big expenses that come with a mortgage is private mortgage insurance (PMI). If you don’t have a down payment of at least 20% of your purchase price, you are expected to pay an insurance premium until you’ve paid down your balance to the point where you owe less than 80% of your home’s value.
It is possible to avoid PMI, though, with a little creative financing. One way is through what is called a piggyback loan.
Why Do You Pay PMI?
First, it helps to understand why you might have to pay PMI. Many lenders require a down payment because they like you to have “skin in the game.” Conventional wisdom says that you if you put in at least 20% of the purchase price, you are more likely to fulfill the loan terms.
When you have that amount of money, your financial situation is considered more stable. Plus, it’s thought you won’t risk losing all your “investment” by walking away.
Remember: the lender is actually putting up the money for your home. If you default, the lender stands to lose out. PMI is a way for the lender to be protected. If you default, the insurance helps reimburse the lender. But, since you are the risky party, the lender expects you to pay the premiums on the insurance.
Getting around it requires finding a lender willing to let you use a piggyback loan as part of the down payment process.
What is a Piggyback Loan?
Your piggyback loan is basically a home equity loan for the portion of your down payment you are missing. One of the most popular types of piggyback loans is the 80-10-10. With this type of piggyback mortgage, you end up getting a loan for 10% of the purchase price and using a down payment for the remaining 10%.
You avoid the PMI because you are only getting your “main” mortgage for 80% of the purchase price. It’s like putting 20% down.
There are other configurations you can use as well, depending on how much you have for a down payment. It’s also possible to get an 80-15-5 mortgage, which means that you get your piggyback loan for 15% of the purchase price and make a 5% down payment.
There are some lenders that will allow an 80-20 arrangement, meaning you use the piggyback loan to make your entire 20% down payment. However, since the financial crisis, you are less likely to find a lender willing to use an 80-20 piggyback loan.
Things to Consider Before a Piggyback Loan
Even though it seems like a good way to avoid PMI, it’s important to understand that piggyback loan isn’t always the best option for everyone. Here are a few things to keep in mind before you go for the piggyback loan:
- Good credit is usually required: First of all, most lenders won’t let you use a piggyback arrangement unless you have good credit. While it’s possible to get a loan in some cases, generally you can expect to need at least a 680 credit score to qualify.
- Variable rate second mortgage: Changes are, your piggyback loan will have a variable rate. Most HELOCs and home equity loans have variable rates. That means your payment could go higher later on, even if your main mortgage has a fixed rate.
- Can be harder to refinance: When you have a piggyback loan, it can be harder to refinance down the road. That includes when you refinance your first mortgage. If you want to refinance, you might need to pay off the second mortgage, or you might need to see if you can get a special arrangement from your lender.
- You might need separate documentation: Depending on where you get your piggyback loan, you might need to supply all your documentation twice. Your piggyback loan is a separate mortgage, so you need to go through the same process.
For some homebuyers, a piggyback loan can be a good solution to paying PMI. However, it’s important to run the numbers and make sure that it really will save you money in the long run, and make it possible for you to get the best outcome for your buying experience.