For many homebuyers, finding a 20 percent down payment for a new home is no easy feat. People who can't scrape together this money must pay Private Mortgage Insurance (PMI) until their home appreciates to an 80 percent loan-to-value ratio. At that point, they can refinance away the PMI.
But many homeowners opt for a simultaneous combination of first and second mortgage loans, which allows them to finance a portion of that 20 percent down payment. Called a "piggyback loan," it enables consumers to bypass PMI.
Which financing arrangement makes the most sense?
Consider the spread
If the rates between the first mortgage and the second mortgage are relatively close to each other, the piggyback maneuver makes dollars and sense. A second mortgage loan at a much higher interest rate means that you could be paying more for the mortgage than you'd pay for PMI.
A short 2nd mortgage term
If you opt for a home equity loan, you can sign on for a shorter term. You can then pay off this second mortgage more quickly than the first, and this arrangement could be beneficial. A second mortgage will probably be pricier, so you'll want to eliminate it as soon as possible.
High tax brackets? More deductions
The interest paid on both loans will be tax deductible. This is appealing to people in higher tax brackets who may be looking for additional ways to reduce their tax obligations to the IRS.
Check the closing costs
Keeping costs low is the key to a piggyback loan. Most second mortgages charge low, or no, closing fees. If the one you're considering includes high closing costs, it might price itself out of the picture.
Appreciate your home's appreciation
Take a good look at how quickly homes tend to appreciate in your targeted neighborhood, and do some number crunching. If it appears that your home will appreciate to the 80 percent loan-to-value ratio mark faster than you can pay off the second, this strategy might be a good choice.
Ultimately, your specific financial situation will dictate the best choice for you. The guidelines above should give you an idea if it's better to go with a piggyback, or PMI, on your next home loan.