How to Avoid Mortgage Insurance with a Small Down Payment

If you're in the process of buying your first home, one of the most important decisions you'll make is how much money to put down. Since most people just starting out don't have a lot of cash, they tend to make a small down payment. But when you do that, you're required to pay mortgage insurance which is very expensive.

Today, there are ways to get around the extra expense.  You can take out what's called a "piggyback" loan. This is the term used by mortgage lenders when referring to a second mortgage that closes simultaneously with the first mortgage. The piggyback can either be a home equity loan or a home equity line of credit, both of which are offered by Quicken Loans.

Avoiding PMI

One of the most common reasons to get a piggyback is to avoid paying private mortgage insurance (PMI), which protects the lender from default. It's cheaper for the homeowner to get two mortgages and the interest is usually tax-deductible (please consult your tax advisor). When you have 20 percent equity or more in the home, you are allowed, by law, to tell your lender to drop PMI. Otherwise, the lender is required to drop PMI when you've reached 22 percent equity. Quicken Loans offers the PMI Buster Loan that allows you to avoid paying costly PMI.

Lower Down Payments

It can also be a way to finance more than 80 percent of the home's purchase price (also referred to as 80 percent loan-to-value or LTV). For instance, if a home buyer only has enough for a five percent down payment, he can get what's known as an 80/15/5. The "80" refers to the first mortgage which finances the first 80 percent of the home's purchase price. The "15" refers to the second mortgage which finances another 15 percent of the purchase price. The "5" is the borrower's five percent down payment. There are two basic permutations to this: 80/15/5 or 80/10/10, however, some lenders do allow an 80/20 in which the second mortgage covers the rest of the purchase price with no down payment.

The Cons

On the flip side, there are first mortgages that allow as high as 95 percent LTV, but with those loans, the borrower must pay PMI. A borrower would typically get this type of loan if their credit score was not high enough to qualify for a second.

The second mortgage is usually financed at a higher rate than the first mortgage since it's tied to short-term interest rates.

Seconds have a shorter loan term than firsts and are usually confined to primary residences. They are also limited to amounts no higher than $100,000; however, there are lenders that allow more. Quicken Loans, the nation's largest online lender, allows as much as $500,000.

The Pros

Getting a piggyback loan can be a nice convenience to home buyers since it closes at the same time as the first. So you don't have to go to two closings and sign two separate sets of paperwork.

Sometimes, the second loan can be structured in a way that gives the homeowner practical use. For instance, if the second loan is a home equity line of credit, the homeowner may draw from the loan to use for say, home improvements.

They may also be structured to allow interest-only payments. This means that for a specified period of time, you only have to pay the interest, though you can add as much principal on top of that as you wish. It gives homeowners the added flexibility in what they can do with their money. They may divert it toward their 401k or other financial investments, paying off high-interest credit card debt, saving for a rainy day or what have you.

Piggybacks have several benefits, but whether or not getting one is right for you is ultimately your decision. If you're buying a home and are not sure if you need a piggyback, it's best to talk to your Quicken Loans home loan expert by calling (800) 963-2177. They will be able to give you the best advice based on your individual situation.

Courtesy of ARA Content