Because home prices have made twenty percent down payments impossible for legions of first time home buyers, a dual-loan concept has evolved for home financing that has made home mortgage insurance companies very unhappy. Also known as ‘private mortgage insurance (PMI), this policy is required of every home buyer who is taking out a mortgage of more than eighty percent of the home purchase price. The policy protects the lender against default, while the borrower pays the mortgage insurance premium. The policy is required until the mortgage is paid down to seventy eight percent of the home’s appraised value.
Home mortgage insurance can be expensive: as high as $1,500 per year on a $200,000 home. Divide that by twelve and you have the addition to your monthly mortgage insurance premium. In order to get around PMI, lenders have been offering dual loan packages with a mortgage of eighty percent of the purchase price and a second loan, called a piggyback loan that covers whatever portion of the 20% down payment that the borrower cannot meet. Thus an 80-15-5 loan package is an eighty percent mortgage, a fifteen percent piggyback loan and a five percent down payment.
While the additional loan will be at a higher rate than the mortgage, the interest on that loan is deductible whereas the premium on mortgage insurance is not. As a result, it is often cheaper to opt for the piggyback loan than mortgage insurance. According to one estimate, forty percent of all home purchases with down payments of less than twenty percent now opt to avoid home mortgage insurance.
Even though the borrower is paying closing costs on two loans, avoiding home mortgage insurance is still a better deal in the short run. Whether or not it’s a better deal in the long run depends on several variables. If the buyer is going to be in the home for a long period of time, he may be better off with the larger mortgage at a fixed rate and paying the mortgage insurance premium until he has sufficient equity. Eventually, the cost of the insurance premium will cancel out.
That process could take several years however, and if a buyer is not going to be in the house for an extended period the choice of dual loans and dual interest deductions may be a better bet – particularly if the principal mortgage is an ARM. Home mortgage insurance companies have responded by hurling insults at all things “piggyback” and by introducing products such as mortgage insurance premiums that are folded into the loan interest rate by raising it a quarter point or some similar amount.
With this design the lender pays the mortgage insurance premium. Because it’s folded into the mortgage premium, the policy premium may be deductible as interest. The policy can’t be cancelled in this model, however; in order to remove it from the mortgage you have to refinance. Home mortgage insurance companies have been lobbying Congress aggressively to provide deductible status for their product.
