Keith Gumbinger HSH.com
The easiest way to avoid mortgage insurance is to make a 20 percent down payment when you buy your home. However, as home price appreciation frequently outstrips the efforts of even the most frugal household, saving 20 percent of the purchase price may be an unattainable goal.
A borrower could avoid having to obtain PMI through a novel lending process called a "piggyback" mortgage. Also known as an "80-10-10" or "80-5-15," these arrangements actually leave you with two mortgages rather than one.
Say you have just 10 percent to put down. Normally, you'll get a 90 percent mortgage, and pay PMI. That PMI premium may or may not be tax-deductible, and it may be some years before it will cancel. With a piggyback mortgage, you obtain a first mortgage for 80 percent of the purchase price, and at the same time get a second mortgage for 10 percent of the purchase price. Together, they'll make up 90 percent, so you still only need a 10 percent down payment (80%-10%-10%; an 80%-5%-15% sees you make a 5 percent down payment).
Your 80 percent first mortgage doesn't require PMI, and the lender who holds the 10 percent second mortgage usually doesn't require it either, or will self-insure it (lender two’s risk is usually very slight, and the loan amount is usually small). As the second mortgage is a mortgage, and not an insurance policy, the interest payments you make are tax-deductible.
Drawbacks of piggyback
Usually, that second mortgage is short-term (typically 10 years), and you pay it off fully, with no cancellation procedure to worry about. There are drawbacks to these arrangements, though. For example, second mortgage interest rates are typically rather high (they can be 6 percent to 8 percent or more), so you may not end up saving much money, if any, over the term.
PMI-avoiding piggyback loans – including no-money-down 80 percent/20 percent versions – have been in and out of the market a number of times in the recent past. However, the risks of making these kinds of second mortgages became all too clear when home prices plummeted and foreclosures skyrocketed. Many lenders found themselves holding worthless piles of paper and with unrecoverable losses from loans they made or bought from others.
As we noted in the earliest parts of this guide, there are well known risks in making loans to borrowers with little skin in the game. The potential for unknown risk is why the HPA and Fannie Mae both mention "any other loans against the property" when it comes to canceling an MI policy.
Regardless, there’s nothing especially risky about a loan with 10 percent down and a 10 percent second mortgage, provided the borrower’s credentials are solid and property prices are stable. Given the right set of conditions, some of these piggyback loan structures will no doubt return to the market. For more about piggyback loans, we suggest you read “Q&A: Piggyback Mortgages .”