PMI protects your lender in the event you default — but you have to pay the premium. Depending on the size of your loan, you can expect to pay $120 or more with each mortgage payment because of PMI. You can avoid this payment, though, with what is known as a piggyback mortgage.
First, understand how PMI works: You’ll pay PMI when you take out a conventional mortgage — one not insured by a government agency — and come up with a down payment of less than 20% of your home’s final purchase price. How much you’ll be charged can vary, but you can expect to pay from 0.5% to 1.5% of your original loan amount in PMI each year. For a mortgage of $300,000, you might pay from $1,500 to $4,500 a year for PMI. That comes out to $125 to $375 a month extra because of this insurance.
You can avoid PMI by putting down 20% of the purchase price when you buy your home. Many buyers, though, don’t have that kind of money. For a home costing $300,000, a down payment of 20% would come out to $60,000. But buyers without that kind of cash have a recourse: They can apply for a piggyback mortgage.
What is a piggyback mortgage?
With a piggyback mortgage, you take out two separate loans: a primary mortgage that covers 80% of the home’s purchase price and a secondary loan, or the "piggyback" loan, which covers 10% of the home’s purchase price. You then provide a down payment of 10% of the home’s purchase price to cover the rest of the loan’s cost.
This structure is why piggyback loans are often called 80-10-10 loans. With an 80-10-10 loan, you are still making a down payment of 20%. You are just financing 10% of that down payment with a second mortgage. By doing this, you won’t have to pay PMI, because your down payment still counts as 20% of your home’s purchase price.
An added benefit? You won’t have to come up with as much cash as when you provide a 20% down payment. Say you buy a home that costs $300,000. With a piggyback mortgage, you might secure a primary mortgage of $240,000 and a secondary loan of $30,000. That leaves you with $30,000 to cover with your down payment.
Now consider buying that same $300,000 home without the 80-10-10 loan. If you wanted to avoid PMI and put down 20%, you’d have to pay $60,000 in cash. You could pay this upfront or roll it into your mortgage amount.
This doesn’t mean that a piggyback mortgage is right for everyone. The interest rate on your second loan, the one for 10% of your home’s price, will usually be higher because it is a riskier loan for mortgage lenders. You’ll also have to make two monthly payments.
Also, PMI isn’t permanent. Your lender must automatically cancel this charge when your loan’s principal balance reaches 78% of the original value of your home. You might want to simply take out a traditional mortgage and wait for PMI to disappear rather than deal with the extra monthly payment that comes with a piggyback mortgage.
But if avoiding PMI is a priority, speak with your lender and your financial advisor about whether a piggyback mortgage is the right move for you.
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