Conventional loans with equity or a down payment of less than 20% will normally require private mortgage insurance (PMI). However, in many circumstances there are advantageous alternatives to traditional PMI.
The factors you will need to carefully consider are your estimates of:
- length of time you will probably live in the home
- interest rate of your loan
- appreciation rate of homes in your area
‘Piggyback’ Home Loans
Piggyback loans, sometimes called 80/10/10 or 80/15/5 loans feature the ability to avoid private mortgage insurance (PMI) when the down payment or equity in your home is less than 20% of the value. By combining a first mortgage and a ‘piggyback’ second mortgage, you may reduce your monthly payments below a traditional mortgage loan with PMI.
‘Piggyback’ loans are available with a down payment of as little as 5 to 10% and may be used with most fixed rate and adjustable rate loans.
- possible lower mortgage payment (no PMI payment)
- possible tax deductibility of the interest versus the nondeductible PMI payments (consult an accountant regarding your individual circumstances)
- lower interest rate (by using a piggyback loan you may be able to keep the first mortgage amount below the jumbo loan limit and take advantage of lower conforming rates versus jumbo rates)
- The flexibility of a home equity loan as a second mortgage
There are two key factors to consider with piggyback loans:
- The length of time that the loan will be outstanding
- Slightly higher cost since there are two loan closings
- The home’s appreciation rate (you may be able to drop PMI if the home appreciates fast enough to reach 80% LTV)
The total payment of the first mortgage and the piggyback loan may be lower than a single loan with PMI. However, you can have PMI eliminated on a loan by either:
- paying the loan down so that there is 20% equity or
- obtaining a new appraisal to demonstrate that you have at least 20% equity. (Please confirm all the requirements with your current loan servicer.)
Of course, if the home has appreciated enough for you to have 20% equity, you could refinance the first and second loan and be left with one new loan without PMI.
Self-insured mortgages or PMI Buyout
Another alternative to a traditional PMI loan is to build the lender’s additional risk into the loan itself. The loan will have a higher interest rate but will not require traditional PMI. The lender for the loan covers the risk internally.
- While the interest rate on the loan will be higher than the same loan with PMI, the payment will usually be slightly lower.
- Since home interest expense is deductible, the after tax cost of the self-insured loan is lower. (Certain self-insured products allow for a reduction in the interest rate when the loan has paid down to 80% of the original value.)
If you live in the home long enough and/or the appreciation rate is high, you may be able to have PMI removed from the loan early. By eliminating PMI you will have a lower payment than a self-insured mortgage. Of course, if the home has appreciated enough for you to have 20% equity, you could refinance to a loan without PMI. If this does happen, you are still stuck paying the higher interest rate if you buyout PMI with a higher rate.