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Weary of Private Mortgage Insurance?
A `Piggy-Back' Loan Offers Alternative
By Karen Hube
A growing number of home buyers and people
refinancing their mortgages may now have a
way to slam the door on private mortgage
insurance.
This insurance, PMI for short, is the expensive
coverage lenders typically require people to
purchase when borrowing more than 80% of
the value of a home.
Thanks to a relatively new type of loan
arrangement that is becoming more and more
widely available, many borrowers now have an
alternative to the unpopular PMI. The
alternative is a " piggyback " loan , which
stacks a small second mortgage on top of a
primary mortgage.
"This can significantly reduce a borrower's
monthly payments," says Mark Smith,
president of the Mortgage Bankers
Association of America in Washington and
chief executive officer of Crestar Mortgage
Corp., a unit of Crestar Financial Corp.,
Richmond, Va. "And the interest on the
second mortgage is tax-deductible -- PMI
payments are not."
Piggyback loans were created a couple of
years ago in pricey markets where borrowers
are more likely to take out hefty mortgages.
But recently, they have caught on nationwide
as more lenders have become more
comfortable making higher-value loans, says
Keith Gumbinger, vice president of HSH
Associates, a mortgage-information provider
in Butler, N.J.
Because these loans are most commonly
designed with an 80% primary loan, 10%
second loan and a 10% down payment, they
are often referred to as "80-10-10s." But
variations, such as 75%-15%-10%, are
possible.
Under traditional mortgage arrangements,
borrowers who need a large mortgage have
little choice but to pay for PMI -- and pay and
pay and pay. The typical cost is 0.5% of the
loan amount and is paid monthly. For a
$200,000 mortgage, the cost would be $1,000 a
year.
The insurance is supposed to provide extra
protection for the lender if a borrower
defaults on a mortgage loan, which already
is secured by a legal claim on the property.
"PMI has no benefit to the consumer," says
Tim Kruger, senior vice president of
Metrociti Mortgage Corp. in Los Angeles.
The coverage is mandatory in most cases
for home buyers who can't come up with a
down payment of at least 20% and
refinancers who haven't built up at least
20% equity. But even when a homeowner's
equity does pass the 20% mark, it can be
difficult to drop PMI. "I have heard of
lenders who won't cancel PMI, regardless,"
says Mr. Gumbinger.
The U.S. Public Interest Group in
Washington and other consumer-advocacy
groups have been pressuring Congress to
enact legislation that would require lenders
to stop billing for PMI automatically once a
borrower achieves certain equity levels in a
property.
Meantime, it is generally up to the
consumer to ask a lender to stop charging
for PMI.
Suzanne Hutchinson, executive vice
president of the Mortgage Insurance
Companies of America, a trade group in
Washington, maintains that dropping
PMI when equity reaches 20% isn't a
problem. And she argues that the
coverage does have advantages for
consumers.
It is less complicated than a piggyback
loan because "you don't need two
applications, two lenders, and you
don't have to make two payments,"
she says. A borrower with a traditional
loan and PMI also may be eligible for
a home-equity line of credit, she adds,
an option not always available for
those with 80-10-10s.
Loans with PMI are still more readily available than piggyback mortgages. For the most part, 80-10-10s are arranged by specialized mortgage lenders and brokers, rather than the ordinary commercial bank, and finding a piggyback mortgage can still take some legwork.
With these new loan structures, the primary mortgage is sold in the secondary market to mortgage investors, such as Freddie Mac and Fannie Mae.
The interest rate on this portion of the package might be about 7%, the current average rate on a 30-year fixed-rate mortgage. The second mortgage is retained by the lender and carries an interest rate that's higher than the primary mortgage's -- typically between 8% and 13%, currently, depending on the borrower's credit rating.
The cost of a piggyback loan depends on a variety of factors, including the interest rates, the size of the loan package and the down payment or equity built up in a home.
Let's say you need a mortgage loan for 90% of the value of a $150,000 home. Now assume you get a traditional 30-year mortgage equal to 90% of the property's value with a fixed interest rate of 7.25%. In that scenario, monthly principal and interest payments would
be $920.93, and monthly PMI payments would be $57.38. Total monthly payment: $978.31.
Instead, say you get a primary 30-year mortgage with the same interest rate for 80% of the value of the home, and a second 15-year mortgage equal to 10% of the property value at a fixed rate of 8.5%. With no PMI to worry about, the total monthly payment would be $966.32.
If you're not inspired to do a jig over a monthly savings of
$11.99, wait -- there's more.
Not only would you be able to write off the interest on the
second loan with the 80-10-10 structure, "you're building
up equity a lot faster," says Mr. Smith of the Mortgage
Bankers Association.
Indeed, in the previous example, a borrower using a
piggyback loan would build up $2,000 more equity over
five years than with a traditional home loan. And after 15
years, once the second loan is paid off, the mortgage
payment would drop to $818.61 a month; with a traditional
loan, the payment would be $920.93 -- assuming PMI
would be lifted by that time.
The savings compared with a traditional loan would be
$18,417.60 over the final 15 years.
Even more compelling for some home buyers, particularly
in areas with high property values, is that piggyback loans
can make higher-priced homes more accessible. That's
because, as a rule, lenders won't grant mortgages for more
than 80% of the value of a home when the property is
valued at more than $400,000.
"We just had someone buy a $1.9 million home with just
10% down -- this wouldn't have been possible before,"
says Mr. Kruger of Metrociti, which arranges piggyback
loans for about 60% of its customers. That is up from 10%
in 1996.
Is a piggyback mortgage for you?
"You've simply got to do the math," Mr. Gumbinger says.
Have your mortgage broker calculate precisely what your
monthly payments would be under the traditional and
piggyback scenarios. If you already have a mortgage that
requires PMI and you are considering refinancing to a
piggyback structure, be sure to factor in refinancing
charges, which can be as much as 0.5% of a loan.
Once you have decided to get an 80-10-10, be sure to comparison-shop. There are generally three types of second loans on piggyback mortgages, each of which would result in a different payment schedule.
Most often, the second mortgage has a fixed rate and is amortized over the life of the loan. But some lenders offer a fixed-rate balloon mortgage. In this case, monthly payments are low, but the balance must be paid off in full after a specified term, often 15 years.
"At the end, you can refinance," says Mr. Kruger. "Or, you sell before that."
In the third type, the second loan is similar to a credit line: You can borrow back any money you have paid on the loan to, say, buy a car or write a tuition check. With these, you pay an adjustable interest rate.
If you think you might want to pay off your second mortgage in full early, make sure the contract you choose carries no restrictions or prepayment penalties.
Finally, avoid mortgage lenders that offer simply to reduce PMI payments if you get a piggyback loan. Says Mr. Kruger: "You shouldn't have to pay for PMI at all."
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