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PMI or Piggyback Mortgage (also known as an 80/20 or 80/10)?
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The most common alternative to paying Private Mortgage Insurance (PMI) is
a piggyback mortgage where a borrower takes out both a first and a second
mortgage rather than paying PMI. A description of a piggyback mortgage is
at the end of this article.
Depending on your personal situation, either PMI or a piggyback mortgage
may be the correct choice.
This article will assist you in determining which choice makes more sense
for you, but to be sure you should consult a mortgage professional with
the exact details of your personal situation to be sure you are making the
right choice.
For a basic rule, (of course, nothing is basic or simple!)
- if you are in a
fixed rate, take the PMI.
- If you will refinance
or move in 5 years take the piggyback mortgage (80/20 or 80/10/10).
- For the least expensive
route, take a 5 year ARM 1st and 2nd piggyback. You can save thousands
over the PMI payments, but it may cost in a higher interest rate later
on.
The Advantages of
PMI are:
PMI does stop or
can be cancelled when the mortgage has been paid down See how to cancel
PMI
The higher interest
rate on the 2nd mortgage can continue on past the time the PMI will stop.
2nd Mortgages can
have balloon payments
2nd mortgages can
have adjustable rates
2nd mortgage minimum
payments can be interest only
A Home Equity Loan
may not be available if there is already a 2nd mortgage
The Advantages of a Piggyback Loan are:
the interest on the
2nd mortgage is deductible.
The total payment
with a second mortgage is often less than a mortgage with PMI
When is PMI Best?
For a borrower keeping a home for longer than 2-5 years.
With a home that is increasing in value at 5% per year, the PMI can be cancelled
after 2 years for someone who already put 10% down as long as the lender
accepts the request. Read how to cancel
PMI for the rules.
For borrowers who only put 3% or 5% down, the time frame is still in the
5 year range, but for these borrowers it will be 4-5 years down the road
or longer before they can cancel the PMI.
My recomendation is that for borrowers who are not active in pursuing their
mortgage opportunities, they go ahead and pay PMI. This option will cost
you money, but save the possibility of higher rates.
When is a Piggyback Loan Best?
For borrowers keeping the home less than 5 years or with plans to refinance
the loan for the purpose of taking cash out or adding to the home.
Even after paying $1500 to refinance, this program is $6,000 to $8,000 cheaper
than the PMI option over a 5 year period.
If you are going to use this home as a step up house and sell it to move
on to something bigger and better, take the piggyback and the tax advantages,
no need for the PMI. Take the interest only 2nd mortgage, pay the least
possible and avoid the PMI.
Since the piggyback loan is best when used for about a 5 year period, seriously
consider this piggyback loan as a 5 year ARM 1st mortgage and a 5 year ARM
second mortgage. We offer a second mortgage for the 5 year ARM that is only
3/8% to 1/2% higher than the 1st mortgage. See example 1 for the comparison
of savings using the 5 year ARM piggyback.
The 5 year ARM program saves almost $1,300 per year on a $150,000 mortgage
or a total of $6,500 after 5 years. Your tax savings from being able to
deduct interest rather than pay PMI save another $400 to $800 per year depending
on your tax bracket.
My recomendation is that If you decide on the Piggyback 80/20 or 80/10/10,
go into it expecting to refinance rather than keeping the 2nd mortgage the
entire life of the second mortgage and take an ARM program rather than a
fixed rate.
What about Refinancing to Combine the 1st and 2nd
Later on?
One way to use the piggyback loan is to intend to refinance and combine
the two loans later on. This is a popular method of saving money and as
I have mentioned above, is the method I suggest for borrowers to take who
are active in the pursuit of savings.
Many mortgage professionals want to only talk about the thousands of savings
that come in the first 5 years with this program, but let's be honest about
this, your mortgage is not going to be paid off in 5 years unless you win
the lottery! You need to have a plan.
A very good method is to take the two 5 year ARM mortgages and then drop
into a 20 year fixed to pay off the mortgage. Sure, 20 year payments are
a little higher, but remember that the balance is lower after 5 years and
your income will be higher.
A plan that cuts off 5 years of payments is worth way more than any savings
along the way.
Even if rates went up 2% during the 5 years, this plan would save you about
$20,000 of interest plus all the PMI premiums you have paid on a $180,000
mortgage.
If interest rates went up over 3% this plan would cost you money.
If that was the case, you would likely take another 5 year ARM package and
wait until rates went down again to get the 20 year mortgage or maybe even
a 15 year mortgage by then.
Downsides to 80/20 and 80/10/10 Piggyback loans
However, there are some possible downsides to this method. That the rates
may be higher when you refinance is the number one downside. You may spend
the entire savings on points buying the rate back down to where you are
today.
The other downside is that if you take a first and second mortgage and do
not refinance, you will pay the higher interest rate on that second mortgage
until it is paid off and that could be for 15 years! In this case you could
pay many times more that it would have cost to just take the PMI.
Do NOT take a piggyback mortgage just to save PMI and then never refinance
unless you are paying extra on the second mortgage to get rid of it. PERIOD.
With 10% Down
In the example below with 10% down, I have shown an interest only second
mortgage with the piggyback example to show that a 2 year savings would
be about $1700.....hmmm just about the cost to refinance the loan, isn't
it?
If interest rates are higher in 2 years, the cost to refinance just for
the purpose of combining the two loans is actually more expensive.
With 10% down, it's a toss up, the costs are not much different and the
PMI is definitely the simpler answer and leaves the door open for you to
take a second mortgage or home equity loan.
With 5% down
In the example below with 5% down, the PMI payment is higher, but that interest
rate on the second mortgage is higher too! With 5% down, it takes about
4 years for the house to increase in value enough to be able to cancel the
PMI.
I have shown an interest only second mortgage with the piggyback example
to show that a 4 year savings would be about $2500.....hmmm... more that
the cost to refinance the loan, isn't it?
If interest rates are higher in 4 years, the cost to refinance just for
the purpose of combining the two loans could be more expensive.
With 5% down, the choice to take a piggyback loan is probably the more attractive
choice although the savings from possible higher interest rates may cost
you the savings down the road. A more conservative borrower may still decide
to bite the bullet and pay the PMI payments just for simplicity.
Comparing the Difference
When comparing the two choices, the obvious answer of which one has the
lowest payment is not always the choice that costs you the least amount
of money in the long run.
This is because the additional PMI payment stops when there is enough equity
in the home, while the higher interest rate on that second mortgage will
continue until the second mortgage is paid off either through refinancing
or paying off the balance.
You need to first consider how long you expect to be in the home and determine
which makes more sense. Then you need to look at the worst case scenario,
so that you will not be surprised if your situation changes.
PMI
Determine how many months till the balance is paid low enough to cancel
the PMI and
calculate the total cost of the PMI payments
Piggyback
Determine the difference between the 1st and 2nd mortgage versus the PMI
mortgage without the PMI payment.
Add to this the the tax savings from being able to deduct the interest on
the 2nd mortgage.
Savings Determination Scenario Assumptions
Here is an actual scenario of a breakdown chart I complete for my clients.
In this case, the Borrower has 700 credit scores, 10% down on a $200,000
home and the choices of paying PMI or having a piggyback mortgage. Tax savings
are based on only a 15% tax bracket. Savings will be higher if you pay higher
taxes.
The 1st case shows a 30 year fixed compared to a 5 year ARM 1st and 2nd
mortgage.
I have also included the 2nd column where the borrower takes a higher interest
rate and the Lender pays the MI just to show how even a half percent higher
is actually a tax savings for the borrower.
Both of the next two cases show a 30 year fixed rate loan compared to a
30 year fixed rate loan. The first is with 10% down and the second is with
5% down.
Here is the scenario for the PMI versus the 5 year
ARM 1st and 2nd
5 years of pre tax savings at $1298.04 per year equals $6,490.20
Less about $1500 to refinance and you still save almost $4500 over paying
PMI
Add in tax savings at the 15% tax bracket of another $400 per year and you
save another $2,000
This is my preferred choice for borrowers.
|
Descriptions for 10%
Down |
Borrower Paid PMI |
Lender Paid PMI |
Piggyback
5 year ARM
Mortgage |
|
First Loan Amount |
$180,000.00 |
$180,000.00 |
$160,000.00 |
|
Second Loan Amount |
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|
$20,000.00 |
|
First Loan Interest
Rate (%) |
5.875% |
5.875% |
5.125% |
|
Second Interest Rate
(%) |
|
|
5.500% |
|
Tax Advantage Interest
Rate (%) |
|
6.375% |
|
|
Monthly First P &
I |
$1,064.77 |
$1,122.97 |
$871.18 |
|
Monthly Second Payment |
|
|
$113.56 |
|
Monthly MI Premium |
$78.00 |
|
|
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Pre-Tax Monthly
Payment |
$1,142.77 |
$1,122.97 |
$984.74 |
|
Estimated First Year
Interest |
$10,489.10 |
$11,415.48 |
$9.040.67 |
|
Estimated Monthly
Interest Paid |
$874.09 |
$951.29 |
$753.39 |
|
Estimated Monthly
Tax Deduction |
$131.11 |
$142.69 |
$113.01 |
|
Estimated After-Tax
Monthly Payment |
$1,011.66 |
$980.28 |
$871.73 |
|
MI Closing Costs |
$78.00 |
|
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First Year Pre-Tax Savings |
$237.60 |
$1,298.04 |
|
First Year Tax Savings |
$454.56 |
$1,679.16 |
|
Descriptions for 10%
Down |
Borrower
Paid PMI |
Lender
Paid PMI |
Piggyback Mortgage
|
|
First Loan Amount |
$180,000.00 |
$180,000.00 |
$160,000.00 |
|
Second Loan Amount |
|
|
$20,000.00 |
|
First Loan Interest
Rate (%) |
5.875% |
5.875% |
5.875% |
|
Second Interest Rate
(%) |
|
|
8.125% |
|
Tax Advantage Interest
Rate (%) |
|
6.375% |
|
|
Monthly First P &
I |
$1,064.77 |
$1,122.97 |
$946.46 |
|
Monthly Interest Only
Second Payment |
|
|
$135.42 |
|
Monthly MI Premium |
$78.00 |
|
|
|
Pre-Tax Monthly
Payment |
$1,142.77 |
$1,122.97 |
$1,081.88 |
|
Estimated First Year
Interest |
$10,489.10 |
$11,415.48 |
$10,971.45 |
|
Estimated Monthly
Interest Paid |
$874.09 |
$951.29 |
$914.29 |
|
Estimated Monthly
Tax Deduction |
$131.11 |
$142.69 |
$137.14 |
|
Estimated After-Tax
Monthly Payment |
$1,011.66 |
$980.28 |
$944.74 |
|
MI Closing Costs |
$78.00 |
|
|
|
First Year Pre-Tax Savings |
$237.60 |
$730.68 |
|
First Year Tax Savings |
$454.56 |
$881.04 |
|
Descriptions for 5% down |
Borrower Paid MI |
Lender Paid MI |
Piggyback |
|
First Loan Amount |
$190,000.00 |
$190,000.00 |
$160,000.00 |
|
HELOC or Second Loan
Amount |
|
|
$30,000.00 |
|
First Loan Interest
Rate (%) |
5.875% |
5.875% |
5.875% |
|
HELOC or Second Interest
Rate (%) |
|
|
10.250% |
|
Tax Advantage Interest
Rate (%) |
|
6.750% |
|
|
Monthly First P &
I |
$1,123.92 |
$1,232.34 |
$946.46 |
|
Monthly Interest Only
Second Payment |
|
|
$256.25 |
|
Monthly MI Premium |
$123.50 |
|
|
|
Pre-Tax Monthly
Payment |
$1,247.42 |
$1,232.34 |
$1,202.71 |
|
Estimated First Year
Interest |
$11,058.32 |
$12,763.11 |
$12,421.41 |
|
Estimated Monthly
Interest Paid |
$921.53 |
$1,063.59 |
$1,035.12 |
|
Estimated Monthly
Tax Deduction |
$138.23 |
$159.54 |
$155.27 |
|
Estimated After-Tax
Monthly Payment |
$1,109.19 |
$1,072.80 |
$1,047.44 |
|
MI Closing Costs |
$123.50 |
|
|
|
First Year Pre-Tax
Savings |
$180.96 |
$536.52 |
|
First Year Tax
Savings |
$560.18 |
$864.50 |
What is a Piggyback Mortgage?
A piggyback mortgage is when a 1st and 2nd mortgage are taken at the same
time in a simutaneous closing. The 2nd mortgage is on top of (piggyback)
the 1st mortgage and the downpayment or equity to make up the entire 100%
of the value of the home.
This avoids the cost of PMI because the first mortgage is only 80% and fits
within conforming guidelines that do not require mortgage insurance on loans
where there is a 20% downpayment.
The second mortgage plus the downpayment that the borrower has available
are combined to make up the remaining 20% of the value or purchase price
of the home. This arrangement is valid even when both loans are with the
same lender because the first mortgage can still be sold to Fannie Mae or
Freddie Mac as a "conforming" mortgage.
These piggyback mortgages are often called
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