Lower Down Payment Options Without the Expense of Mortgage Insurance

New York Times writer Tara Siegel Bernard reported last week that, “It was a year of firsts: In 2015, Kristian and Michele Klein welcomed their first child, a daughter, and bought their first home — a freshly renovated four-bedroom Cape Cod in Glen Head, N.Y.

“But instead of making a traditional down payment of 20 percent — the magic amount often needed to avoid the added cost of mortgage insurance — they put down just 10 percent, still a significant sum, on their $685,000 house. Yet they managed to circumvent the insurance, saving more than $250 a month.

“How did they do it? They took out one loan equal to 80 percent of the purchase price, and another loan for 10 percent — something that has traditionally been called a piggyback loan or a second mortgage.”

The Times article explained that, “With home prices on the rise in many parts of the country, coming up with 20 percent can seem an insurmountable task for prospective homeowners of all income levels. Last year, about 65 percent of all home buyers — or 1.9 million borrowers — put down less than 20 percent, according to an analysis by Inside Mortgage Finance that covered about 80 percent of all mortgages and excluded jumbo loans.

“While most lenders require mortgage insurance on loans with smaller down payments to compensate for their extra risk, there are several options that do not. A few new programs have become available postrecession, while some older strategies have been resurrected, including the piggyback loan. All let borrowers avoid the added monthly expense of insurance, which generally costs from 0.3 percent to more than 1 percent of the loan amount annually. But borrowers may pay a slightly higher interest rate instead.”

Ms. Bernard added that, “A new program from Bank of America, in partnership with Freddie Mac and a group called Self-Help, avoids the insurance altogether, even though it permits down payments as low as 3 percent…[T]hen there are the thousands of credit unions across the country that have a little more leeway in offering low-down-payment loans without insurance, largely because they keep their loans on their own books.”

The Times article indicated that, “The piggyback or second mortgage — not to be confused with the versions misused during the housing bubble, which permitted up to 100 percent financing — can take different forms. The second loan may be a home equity line of credit, which typically carries a variable rate that is based on the prime rate plus an additional margin set by the lender. It generally requires only interest-only payments, but adjusts to a principal and interest payment after 10 years. (Fixed-rate second mortgages, say over a 20-year term, may be also available, but rates are usually higher than the line of credit.)

“Using the line of credit can be a more economical option, even when factoring in principal payments. But the buyers need to be disciplined about paying down the principal. And there’s the risk of rising interest rates, which is a reason some loan officers suggest using this option as shorter-term financing.”

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