80/20 Loans vs Private Mortgage Insurance

Financing a home purchase with 80/20 loans will allow you to avoid paying private mortgage insurance, or PMI for short. An 80/20 allows a borrower to finance their downpayment and doesn't require anything down from the consumer, saving the borrower a lot of money.  Another advanatage is a lower overall monthly payment because the loan removes private mortgage insurance, which can be costly.  The disadvantage with these loans is that the home is fully levaraged with no room to grow, refinance, or change loan terms.

What Is 80/20 Financing?

Homes purchased using 80/20 loans require zero down payment.  The borrower has a first loan of 80 percent of the home's purchase price and a second loan of 20 percent. There are two separate loans. Interest rate of the first mortgage is lower than the rate of the second mortgage because first mortgage rates tend to be significantly lower.  For example, it is very possible to have a 7.00 percent rate on a first mortgage and a 13.00 percent rate on your second mortgage. The combination of the two rates is still lower than a loan with PMI.  

What Are The Advantages and Disadvantages? 

The first advantage of 80/20 loans is that you have no down payment. This allows you to get in a home without upfront cash.  Another advantage is you avoid PMI with 80/20 loans. Private mortgage insurance, PMI, is required on all loans with a down payment of less than 20 percent of the purchase price.  PMI can be expensive and does not go away until you have at least 80 percent invested in your home, which can take many, many years.  With a 80/20 loan, however, lenders do not add PMI and treat your home purchase as if there were a 20 percent down payment, even if the 20 percent second was financed. 

It is important to know that there are risks with 80/20 loans. First, the closing costs on the loan tend to be more expensive, since you are closing two loans at once. Overall, you will pay higher total costs to close. There is also a great loss if your home loses value. Financed at 100 percent, you will not be able to sell the home because you wouldn't have sufficient funds to pay off the loan. This is commonly termed being "upside down." or "owe more than your property is worth."  You must have good credit and a be able to qualify for 80/20 loans.  In today market, 80/20 loans are no longer available because of our current housing crisis. These loans are particular susceptible to economic conditions and have all but disappeared for now.  In times of rising housing prices and strong housing sales, lenders, competing for your business, will offer creative financing such as 80/20 loans. In times of low sales and falling prices, as we are experiencing today, 80/20 loans are not offered.

What Is Private Mortgage Insurance

PMI is an independent insurance policy a lender requires you to obtain prior to closing on a home loan when you are financing more than 80 percent of the home's value.  Typically PMI costs about half of a percent to 1 percent of the total loan amount. As an example, in a $200,000 home with 10 percent down, you are borrowing $180,000. PMI would be $900 a year, or an additional $75 rolled into your total monthly mortgage payment.

The Good and Bad About PMI

PMI allows those who cannot afford a 20 percent down payment on a home buy a home.  The lender takes out insurance for the borrower. PMI is assessed on your loan until you have paid down your mortgage to 80 percent of the home's value.  Once you are at 80 percent of the value, the PMI is removed by the lender.

The downside of private mortgage insurance is the cost. Many consumers that can not qualify for a 80/20 loan will be required to include PMI in their monthly payment, bringing their monthly mortgage payment higher. It becomes more difficult to qualify for a home when you add PMI to the overall mortgage picture.