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You don't have to pay PMI Lenders are increasingly letting home buyers who lack a 20% down payment use a second mortgage instead of private mortgage insurance. The advantage to you: the interest on the second mortgage is deductible. By Karen Hube When Howard and Jessica Drossin put a 10% down payment on a house last month in Studio City, Calif., they figured they would have to pay for costly private mortgage insurance.
Traditionally, homebuyers who put less than 20% down on a property have to pay for private mortgage insurance -- commonly known as PMI -- to protect the mortgage lender in case of default. But like many people these days, the Drossins discovered an increasingly popular alternative to PMI that could save them a bundle over the long term: a piggyback mortgage. Rather than taking out a single mortgage, with a piggyback loan you stack one small secondary mortgage on top of a primary one. In the Drossins’ case, they took out one loan for 80% of their home’s cost, and another one for 10% of the cost. While not everyone comes out ahead with a piggyback loan, it’s worth crunching the numbers to find out: In the Drossins' case, “we lowered our monthly payment by $134 a month,” says Howard, 36, a composer. More reasons to piggyback Aside from monthly savings, there can be other big advantages with a piggyback arrangement, including: The interest on the second loan is deductible. Monthly PMI payments -- which can run $25 to $250, depending on your loan amount and other factors -- are not. What’s more, you can typically pay off a second loan early without penalty. If you do, you’ll be left with only your primary mortgage and your monthly mortgage payments will be significantly lower. With PMI, the insurance payments are supposed to drop away after you build up equity in your home equal to 20% or more of the original value of the home. Your monthly mortgage payments will be the same. (The PMI should terminate automatically under federal law once your equity hits 23% of original value. If home values are rising and you can prove how much greater your equity is, you can also ask to have it cancelled.) “If you’re in a circumstance where your cash comes in lumps, you could get a piggyback loan, pay it off in a few years and save a bundle in interest charges,” says Keith Gumbinger, vice president of HSH Associates, a mortgage-data publisher in Butler, N.J. Let's say your purchase price is $250,000 and you put 10% down. According to Metrociti Mortgage Corp. of Encino, Calif., if you took a 90% fixed 30-year loan with a 6.75% interest rate, your monthly principal and interest payment would be $1,459 and your PMI payment would be $97. In sum, your total monthly payment would be $1,556. (Rates are likely to stay at 7% or lower for the rest of 2002.) If instead, you got a primary loan for $187,500 at 6.75% and a 17% secondary loan for $37,500 at 7.87%, your monthly payment on the primary loan would be $1,216 and on the second loan, $272, for a total of $1,488. All of the interest would be deductible, and, once you pay off the second loan, your monthly payment would drop to $1,216. By contrast, after the PMI is no longer required, you’re still paying $1,459 a month. Avoiding jumbo loans In some cases, a piggyback loan may be a good idea even if you’re putting 20% or more down on the home purchase, says John Murer, a loan officer at Blue Star Mortgage Group in Syosset, N.Y. Here’s why: Loans over $300,700 are considered jumbo mortgages and come with interest rates that are typically three-eighths to a half percentage point higher than for smaller loans. Fannie Mae and Freddie Mac, two government-regulated mortgage investors, don’t invest in loans of more than $300,700 -- a threshold adjusted annually according to the Federal Housing Administration’s home price index. Loans above that amount are bought by independent mortgage investment firms and usually carry higher rates because they are less easy to market, and therefore riskier. So if you need a loan for, say, $320,000, you can probably get a better deal if you got a piggyback with the primary loan less than $300,700, rather than one jumbo loan, Murer says. But, Gumbinger cautions, “You really have to run the numbers to see if a piggyback loan will save you money.” Whether it makes sense depends largely on the interest rate you get on the second loan and how soon you plan to pay it off. While the average interest rate on 30-year fixed primary loans has been hovering around 7% for months, secondary loans typically come with an interest rate at least one percentage point higher. Generally, the smaller the second loan, the higher the interest rate. “For loans over $50,000, you may be looking at about 8.1%,” says Tanya Kramer, a loan officer at Wilson Mortgage Services in Allentown, Pa. “If you’re borrowing $10,000 to $25,000, rates can be 9.75% right now.” If you have to pay such a high rate compared with the rates on a plain-vanilla 30-year loan, your monthly payments may be cheaper if you bite the bullet and pay PMI, she says. Another option The good news is that the mortgage insurance industry knows what competition is when it sees it. So, in response to the threat of a growing piggyback market, lenders have come up with a new PMI option that can significantly reduce the monthly cost of PMI. Called the finance single premium option, “it lowers monthly payments to the same level or lower than piggyback loans,” says Geoff Cooper, director of housing policy at Mortgage Guaranty Insurance in Milwaukee, one of the largest mortgage insurers. This alternative allows homebuyers to pay a single premium on their insurance that is amortized over the life of the mortgage term. Problem is, it’s tough to find a lender offering the finance single premium option, because Fannie Mae and Freddie Mac -- the two largest buyers of mortgage loans -- won’t do business on a loan with this kind of PMI structure. How to make piggybacks work Cooper thinks this will change in the near term, making the mortgage market even more competitive than it is now. In the meantime, there are ways to try to reduce your monthly payments using a piggyback loan. For example, your principal and interest payments will be much lower if you take out a 15-year fixed second mortgage paid off on a 30-year schedule, says Joe Parisi, a senior loan consultant with Metrociti. Keep in mind, though, this is only a good idea if you think you will be moving or refinancing before 15 years is up. That’s because in the 15th year, many of these loans contain a balloon feature: You have to pay it off or refinance your home entirely. If you refinance on a 30-year term, your overall mortgage costs will be much higher than if you had simply paid PMI. Another way to structure a piggyback loan so your monthly payments are low is to stack an equity line of credit on top of a primary loan. Interest rates on equity lines are usually one or two percentage points above the prime rate (currently 4.75%), and they are variable. “This can keep your costs down -- and another good thing is that when you’ve paid down the line of credit, you have an open line of credit,” Parisi says. Piggyback mortgages have been available for about four years. Traditionally, Freddie Mac and Fannie Mae were leery of backing primary loans under the piggyback structure. But the big mortgage investors have become much more willing to get involved with piggyback loans in recent years. Under the piggyback structure, the primary loan is purchased by Freddie Mac, Fannie Mae or other large mortgage investors. The second loan is typically retained by the lender who originally finances the home. The potential market for these kinds of loans is huge – currently an estimated 20% to 25% of all outstanding mortgages under $300,700 carry PMI, according to the Mortgage Insurance Companies of America in Washington D.C. While there are no national statistics reflecting the popularity of piggyback loans, many companies report a significant increase in demand for these products in the last couple of years. Kramer, of Wilson Mortgage, says that about 80% of her customers who put less than 20% down get a piggyback loan. Two years ago, she did no business using financing with these features. “People come to me asking about them,” she says. Similarly, Parisi of Metrociti says almost none of his customers pay PMI anymore. “The only time we do PMI is if a customer can’t get approval on the second loan,” Parisi says. When to say 'no' If you decide to research which loan structure makes sense for you, you may stumble across yet another way to avoid PMI. Some lenders will tout no-PMI loans for more than 80% of a home’s price. The catch: They charge a higher interest rate. In these cases, the lender usually pays mortgage insurance for the borrower, Gumbinger says. The monthly costs, he says, “can be comparable to paying the mortgage insurance yourself, or to a piggyback loan.” But keep in mind that if you plan to keep the loan long term, you will be paying a higher interest rate long after your PMI payments would have fallen away. The bottom line: Don’t jump simply because you hear “no PMI.” Get out your calculator (or ask your loan officer to) and let the numbers speak for themselves. 
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