If you are unable to put 20% down on the home you purchase, you have two options – pay PMI or take out a piggyback loan. Either way, you help lessen the risk the lender takes by providing you a loan without a large down payment. Both choices have the same end result – you secure more than 80% of the value of the home in home loans. Aside from that, however, there are many differences. There is no right or wrong answer regarding which situation is right – it depends on your exact situation and how you want to proceed. Here we will look at the pros and cons of each situation.
WHAT IS A PIGGYBACK LOAN?
First, we will discuss the piggyback loan. For all intents and purposes, it is a second mortgage. It provides you with 10% of the value of the home, in most cases. If you secure 80% on your first mortgage, 10% from this loan, and you put down 10%, you have the full amount you need to purchase a home. Because your first mortgage does not exceed 80%, you don’t have to pay PMI. The money you pay back towards your loan goes toward the principal and interest, helping you to see a return on your investment in the future. The piggyback is a 2nd mortgage. It may be a home equity line of credit or home equity loan – it depends on what you qualify to receive.
THE PROS OF THE PIGGYBACK LOAN
Now let’s look at the benefits of the piggyback loan. The first obvious factor is you don’t have to pay PMI. For many people this makes the second loan well worth it. PMI can get costly and you never see anything from these payments you make. They are insurance premium payments – you do not add value to your home or get any type of refund for paying the premiums.
Another benefit of this option is the ability to secure financing for a large amount of money. Let’s say the home you wish to purchase would require you to take out a jumbo loan. This is a non-conforming loan and has many restrictions, making it hard to qualify to obtain. If you don’t qualify for the jumbo loan, you might not be able to secure financing for the home you want. When you break up the loan into two smaller loans, the ability to secure an approval becomes greater, especially
Lastly, there are often tax benefits when you secure a first and second mortgage. You probably would not be able to write off the PMI you pay, but interest on your mortgage is tax deductible, especially for a purchase loan. If you were to refinance and take cash out of the equity of your home, you might not be able to write off the interest, but when you purchase a home you can.
THE CONS OF GETTING A SECOND LOAN
Just as there are pros for the piggyback loan, there are some downsides. Most people agree that paying for two loans is a definite downside. You pay not only interest on two loans, but you have to pay the closing costs for two loans. Purchasing a home is expensive as it is and having to pay those costs twice can be too much for some people.
In most cases, the second mortgage also carries a higher interest rate. The higher your interest rate gets, the higher your loan payment will be. This can increase your debt ratio and make it harder to qualify for the loan. Even if you do qualify, it can be harder to afford the second mortgage. Unless you refinance or sell the home, you are stuck with the second mortgage until you pay it off.
PAYING PMI – IS IT WORTH IT?
Paying PMI might seem like a bad idea all around. After all, who wants to pay insurance premiums and not see any return on their investment? In reality, you do get a return on your investment – you get to live in the house that you did not put 20% down on. Many people overlook this fact, though. Without the PMI, you might not have been able to purchase your home.
Aside from the benefit of securing financing, PMI has the great benefit of being able to be canceled down the road. This is unlike a piggyback loan. That loan you are stuck with until you somehow pay it off. With PMI, though, the law allows you to cancel it once you hit below 80%. In fact, most programs automatically cancel PMI when you hit 78% LTV. You will be able to tell when this will occur by looking at your amortization table from the closing. If you don’t want to wait that long, you can choose to pay for an appraisal at some point down the road to see if your home increased in value.
The difference between PMI and a piggyback loan is obviously vast. However, you see a return on your investment on one and not the other. Deciding what is right for you really depends on your financial situation. Can you afford a second mortgage with a higher interest rate? Can you see yourself paying this loan for the next 20-30 years? If you don’t want the responsibility of another loan, can you handle paying insurance premiums between an average of $100-$200 per month for the next few years? The length of time you have to pay PMI depends on the loan amount and how much money you put down.
Whatever you decide, make sure you really understand your situation. Look at both possibilities and calculate the differences over time. This will help you decide what is right for you and your family. Either way, you are committing to many years of consistent payments. Make sure to weigh your options carefully in order to make the right decision for yourself.