Conventional wisdom tells us to save for a down payment when purchasing a home. Twenty percent happens to be the magic number. In today’s world, however, this just isn’t the norm. Between the over-inflated housing prices and America’s scanty savings rates, many are finding that they have to explore other options.
If you’re going to buy a house without putting any money down (or less than 20%), there are two main options. You can get a single loan of up to 100% percent of the purchase price of the home, in which case you’ll be forced to pay Private Mortgage Insurance, or PMI. You could also get a loan for 80% of the purchase price and another piggy back loan for the other 20%.
So which choice is the better choice? Or is one better than the other?
With the first option, you’ve got one loan that’s typically at a competitive interest rate that keeps the payment low. The downside to this option is that the lender will make you pay an insurance premium called Private Mortgage Insurance. The policy insures the lender against a default because they’re lending more than 80% of the value of the home. It has no benefit to you, and is the reason your payment will be higher.
If you choose the second option, you won’t have to pay for PMI. What you’re essentially doing is getting a loan for your 20% down payment and financing the other 80% separately. This would seem like the better option except that the smaller loan, or piggy back loan, is financed at a higher interest rate. This will also serve to raise the payment amount.
As far as your monthly payment is concerned there is no clear winner between these two options. It’s usually a good idea to get a quote for both of these options.
It used to be that only the mortgage interest was tax deductible and you couldn’t deduct your PMI payment. This has changed, however, as of 2007. Now you can also deduct your Private Mortgage Insurance payments. So, it would seem that both are viable options.
I, however, still prefer to go with the 80/20 loan split as long as the monthly payments are comparable. With this option you’re able to lower your monthly payment once you pay off the smaller of the two loans.
If you’ve got a loan with PMI, it’s a more involved process in order to remove it and lower your payment. You’re able to remove your PMI payments once you’ve payed the loan down to 80%, but it doesn’t just automatically get removed usually until the loan is down to 78%. If you believe that you’ve already got 20% equity in your home at some point then you’ll have to go through the process of ordering an appraisal and proving to the lender that you indeed have 20% equity.
While these two options are different in how they work, they provide very similar outcomes. The choice between them is then left up to your personal choice and what will work best for your particular situation. As I stated before, it’s best to get a quote for both scenarios. You can then compare the two options and make an informed decision.
What are your thoughts?
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by Katie B., on May 22 2007 @ 12:17 am
One thing I’d like to point out is that PMI is not tax-deductible for everyone. You can take the full deduction if you make less than 100,000, however the deduction phases out extremely rapidly after that point and is phased out entirely at $110k. PMI is only tax-deductible for loans closed in 2007, plus the law will need to be extended past 2007 by Congress in order for taxpayers to still be able to take the deduction in subsequent years.
Just some important food for thought!
by front runner, on May 22 2007 @ 2:06 pm
While I’d try to save for the down payment, having an 80/20 is a great way to get into a house sooner. I’d also try and then make extra payments though.
by Christopher Smith, on May 23 2007 @ 10:23 am
Note that you can get rid of your PMI obligation once property values rise - subject to your lender’s rules.
A few years ago I bought a pair of patio homes as invstments and financed them through my credit union w/ a 10% down payment on each, requiring me to pay PMI.
I got the properties at a great price. I went back to the credit union, ordered an appraisal, and got the PMI released.
Call your lender and get their rules. You generally have to have owned the property for a certain period of time, have no late payments, use an approved appraiser, and have a certain loan-to-value ratio.
Great blog…keep up the good work.
PS: note also that a piggy-back loan is often of a shorter maturity, say fifteen or twenty years - which effectively raises the monthly payment on this debt.
by limeade, on May 23 2007 @ 10:53 am
Thanks for the great points and clarification.
Regarding Chistopher’s comment: Although some piggy back loans can be of a shorter maturity, a lot of them are still amortized over 30 years with a balloon payment after, say, 15. This means the payment is still calculated as if the loan were for 30 years, but after 15 years the remaining balance becomes due. Just make sure to check with the lender to be sure of the specific terms.
Thanks again.
-limeade