Ask your loan officer to list different financing options so you can compare payments and costs.
The mortgage industry holds the 20 percent down payment as the standard for a home loan that can be approved without the backing of a government program or the payment of private mortgage insurance. PMI will boost the size of your monthly payment if you have less than 20 percent of the purchase price of your home. Fortunately, alternative financing programs allow you to have your low-down, no PMI cake and eat it too.
Reason for Private Mortgage Insurance
Mortgage lenders have set the 80 percent loan-to-value level as the maximum to be loaned on a home without some form of additional security for the lender. Banks believe a buyer who puts that much money into his home purchase will be less likely to default on the loan. Private mortgage insurance allows a buyer to put up less than a 20 percent down payment. The insurance covers the lender for the amount of money at risk between the 80 percent loan-to-value and the actual percentage of the loan.
Piggyback Mortgage Option
One way to finance with both a lower down payment and no PMI is to
use a second mortgage loan to cover part of the 20 percent. Lenders refer to this strategy as a piggyback mortgage arrangement. For example, the buyer puts up a 10 percent down payment, takes an 80 percent conventional mortgage, and funds the remaining 10 percent with a second mortgage. A lender would call this arrangement an 80-10-10 piggyback mortgage. With 5 percent down, the financing would be an 80-15-5 piggyback. The trade-off for a piggyback arrangement is the higher interest rate and shorter term on the second mortgage, resulting in a higher monthly payment until the second is paid off.
Lender Paid Mortgage Insurance
Instead of requiring the buyer to pay for private mortgage insurance, some lenders pick up the cost of PMI, allowing a buyer to pay less than the traditional 20 percent down. Of course, a lender will not offer this service for free. To cover the cost of the PMI, the lender charges a higher interest rate than on a loan where the buyer has the 20 percent down. Still, with the lender paid PMI option, the payment could be lower than with buyer paid PMI and the larger amount of interest paid is tax-deductible.
Compare Choices for Short and Long Term