Nearly half of all first-time homebuyers financed the entire cost of their home rather than paying a hefty down payment. And many of these zero-down buyers did so thanks to the so-called 80/20 mortgage plan. This relatively new type of loan was designed to help buyers who want to avoid paying down payments. As housing prices have skyrocketed, more and more buyers with good credit and high incomes find that they cannot afford a home because of the difficulty in saving up enough to make the large down payment. On a home worth $200,000, a 20 percent down payment is a whopping $40,000. To respond to this challenge, mortgage companies began offering the 80/20 option.
Sometimes the 80/20 is referred to as a “piggyback” loan because, in reality, two loans are working in tandem as one. The first part works conventionally for 80% of the purchase price. The 2nd part – the smaller one – is a 20 % loan. So, when you apply for your mortgage, the lender qualifies you for 100 percent of the purchase price of your home and then divides the loan into two sections. By doing this type of loan, you can avoid what is becoming an expensive portion of many mortgages, Private Mortgage Insurance, or PMI. Also, when shopping for a traditional loan, interest rates for a 30-year fixed loan may be lower. Check rates HERE.
For example, if you want to buy a house worth $100,000, the down payment of 20 percent will cost $20,000. With an 80/20 mortgage, the lender gives you $80,000 at one interest rate, then gives you the 20 percent down payment of $20,000 at a somewhat higher rate for a total loan amount of $100,000.
Splitting the mortgage into two parts helps you qualify for the loan without a down payment. Normally you have to put 20 percent down to get a conventional 80 percent loan, so with this rather clever mortgage plan, the lender lets you borrow your down payment. Then the same lender can let you borrow the rest of the loan. To see what the loan will cost you regarding principal and interest, use a loan calculator or get one KG Meyer PC Loan Spreadsheet.
Yes, it sounds slightly contrived and is a rather complicated way to arrive at a basic mortgage. But what counts for those trying to avoid a big down payment is that it helps overcome the down payment hurdle.
You can expect higher rates on the down payment or a 20 percent portion of the loan. But the rates are still reasonable, and this loan arrangement allows you to buy without first saving massive amounts of money to use for your down payment. Later, that option is available if you decide to pay off the 20 percent loan to lower your monthly payments. Many homeowners refinance once they have had a few years to increase their equity and convert their 80/20 into a more traditional type of mortgage.
When looking at these loans, it is important to understand that the 80% traditional mortgage needs to be a fixed-rate 30-year mortgage. For why you need to do a 30-year mortgage, please read our previous post at Benefits of a 30-year Mortgage. Then it is important to be knowledgeable that the 20% loan is generally a balloon payment loan. This means that the monthly payments will generally be lower for most of the loan’s term, with a large balloon payment at the tenth year’s maturity.
For more information on how you may want to structure your mortgage, please get in touch with me if you live in or around the metro-Nashville area. For those outside the middle Tennessee area, feel free to contact me or seek out a qualified fee-only Registered Financial Consultant (RFC) near you.
