Should you do a piggyback loan to avoid PMI?

Ready to close a home loan and don’t have 20% cash or equity to put down on your home then you have herd your lender talk about PMI or private mortgage insurance. PMI is insurance that you are required to pay if you don’t have at least 20% equity in your home. There are way around PMI, one of the most common being a piggyback loan, but should you use the alternative methods to avoid PMI?

A piggyback loan is basically taking out a home equity loan on your home at the same time you setup your original mortgage. Your main mortgage is 80% of the value and the second loan is for the other 20%. The second loan is through a different lender and carries a higher interest rate than the first loan because it is a home equity loan. Usually second loan is for a shorter term such as 15, 20, or 25 years to get a little better interest rate.

In most cases you shouldn’t do a piggyback loan in order to avoid PMI, why? Because private mortgage insurance falls off once you have the 20% equity in your home, you just need to contact your lender when you have the equity. Most lending institutions require you to pay at least 5% down on the home so you already have 5% equity in the home. Second, usually the home you are purchasing will appraise for a little more than you actually pay for the home which gives you additional equity. For example, you purchase a home for $200,000 that is actually valued at $210,000 you pay $10,000 down on the home leaving you with a balance of $190,000 and a value of $210,000. You already have about 10% equity in the home.

Now let’s look at two examples to explain further, one if you do a piggyback loan and one if you do a traditional 30 year loan with PMI.

First example, will be the piggyback loan on the same numbers we just discussed. You pay down $10,000 leaving a balance of $190,000. Remember, the value of the home is $210,000. In order to have the 20% equity and avoid PMI you will need to pay the loan down to $168,000 ($210,000 * 0.80). So, the first loan will be for $168,000. The second loan will be for the remaining balance ($190,000 – $168,000) or $22,000. The first loan is setup on a 30 year fixed loan at 6.5% interest and the second loan is setup on a 25 year fixed at 8% interest. The total payment would be about $1,230 ($1061+ $169) per month.

Second example will be a 30 year conventional loan for the entire balance of $190,000. The interest rate will be very close to the same as above so $190,000 at 6.5% for 30 years is a payment of $1,200 per month. Now you have to add back in PMI which will cost you about $80 per month for a total payment of $1,280.

The piggyback loan sounds much more tempting, right? You will save $50 per month and you will pay off the second loan in 25 years making your monthly payment drop $169 per month. However, remember PMI drops off once you have 20% equity in your home. If you continue to make normal payments on the home this will happen somewhere around the 90 month mark of the loan making your payment drop about $80 per month. Continue to make the normal payments on the loan and you will pay off the loan about 38 months quicker! The other method only pays it off 9 months quicker!

This is a good lesson with any financial matter, make sure you understand all the math associated with a purchase before making the final signature. Just because it sounds like the smart move, it doesn’t always mean it’s the best!