Don’t Have 20% for a Down Payment? Here’s Another Option

BY Ori Zohar

You’ve found the home of your dreams. It’s perfect. You knew it had to be yours the moment you walked through the door. But there’s a catch. Maybe you don’t have 20% for a down payment and want to avoid having to pay the private mortgage insurance (PMI). Or you have enough cash to put down, but the amount you’ll be financing puts you into a jumbo loan, which comes with a higher interest rate. Or it could be perfect with just a little work – but if you put your available cash down to buy it, you’ll have no money left to fix it.

What’s the solution? A purchase money second mortgage might just be your answer.

How does it work?

When you take out a purchase money second mortgage, you’re assuming two mortgages instead of just one. A purchase money second mortgage – sometimes known as a “piggyback second” – is taken out at the same time as your primary mortgage. Typically, that’s the first mortgage with a home equity loan or home equity line of credit (HELOC) added on. The second loan, which may come from a different lender than the first mortgage, usually has a slightly higher interest rate.

The typical formula for the loans is 80/10/10. That means the first mortgage has a loan‑to‑value (LTV) of 80 percent, the second has a 10 percent LTV, and there’s a 10 percent down payment.

Spend more, save more

A purchase money second mortgage can allow you to buy more house while paying less for it. In most cases, it can make sense to take out the second mortgage rather than pay PMI on the first. Even with the typically higher interest rate (compared to the first mortgage), total monthly payments will almost always be lower than for one loan payment with PMI.

Another situation where the piggyback second mortgage makes sense is when you’re buying a home and can put down 20 percent, but the total cost of the mortgage pushes it out of conforming range and into a jumbo loan.

The limits depend on the area you’re buying in, but jumbo loans almost always carry higher interest rates than conforming loan. Breaking a jumbo mortgage into two loans, each with lower interest rates, will save money over time.

If you use your second loan to purchase or improve your home, the interest you pay on amounts up to $1 million is tax deductible, just like the first mortgage.

An additional benefit of structuring the financing this way is that as you pay down the principal balance on your purchase money second, you have access to a portion of your home equity.

Finally, with a purchase money second mortgage, you never have to go through the hassle of dropping your mortgage insurance once you’ve paid off your 20% down payment amount.

Is it right for you?

Purchase money second mortgages won’t be a fit for everyone. There’s a bit of risk. Because a HELOC is usually tied to an index, when that moves up or down, the interest rate goes with it – effectively making it an adjustable‑rate mortgage. So you could end up with higher payments than you anticipated.

In general, purchase money second mortgages make the most sense for homebuyers who don’t have cash for a 20 percent down payment, but are otherwise financially stable. By putting down 10 percent and financing the rest split between two loans, you can avoid PMI.

It can also make sense if you have enough cash to make a 20 percent down payment, but you need to upgrade things like HVAC systems or appliances or want to renovate and improve the home immediately. With a purchase money second mortgage, you can finance more and cut your down payment, allowing you to use the cash you’ve saved immediately to use for upgrades and repairs.

Finally, if you want to avoid paying the higher interest rate on a jumbo loan, the combination of a first mortgage and a purchase money second mortgage can result in lower monthly payments if the combined interest payments on the two loans are lower than one on the jumbo loan.

Still have questions? Get them answered by a Sindeo mortgage advisor – contact us at (855) 746‑3361.