Private mortgage insurance is required when you purchase a home with a down payment of less than 20% of the sale price or the appraised home value, whichever is less. Your lender in this case will expect you to purchase a private mortgage insurance policy so that even if you default, he can compensate for the loss. So when you make low down payment on your home purchase, you pay for the insurance premiums on a monthly basis till you can build up sufficient equity in your home.
You can avoid PMI premiums if you are approved for a piggyback mortgage loan. These loans involve 2 mortgages combined in the ratio of 80/20, 80/15/5 or 80/10/10. This implies that you take a first mortgage against 80% of your home value and second mortgage against the remaining 20% the property value.
Otherwise, you can opt for a first mortgage against 80% of the property value with a second mortgage worth 15% and make a down payment of 5% on the sale price. The third option is that you make a 10% down payment on the sale price and then go for a first mortgage of 80% along with a second mortgage loan against 10% property value.
But the question remains as to which is the best option whether you go for a home loan with a PMI or you look for a piggyback mortgage.
With a mortgage loan requiring PMI premiums, you dont get the advantage of tax deduction, as these premiums are not deductible. But for a piggyback loan, the interest payments on both the mortgages are tax deductible. Thus, you get the opportunity to make savings. But then with this kind of a mortgage, you are required to pay off the second loan at a higher rate of interest compared to the first. This is because if you default, the second mortgage has to be paid back after you repay the first. So lenders consider it a big risk to offer a second mortgage in such situations.
But in case you go for a mortgage with a PMI and home values go higher, you can build up equity faster and this will help you to get rid off insurance premiums in a shorter time than when the home prices are stable. Moreover, the monthly premiums decline when you are closer to building up 80% of your home equity. Even if these do not work in your favor, you can go for a lender-paid mortgage insurance or LPMI policy which allows for a rollover of the PMI costs into the mortgage itself. But most experts dont approve of this policy as the payments are amortized throughout the loan term.
On the other hand, if you go for piggyback mortgage, it will help you to avail a larger loan amount and at the same time give you the opportunity to keep the primary mortgage below the conforming loan limit. You can avail the difference in the loan amount and the conforming limit from the second mortgage and this will prevent you from paying higher interest on the primary mortgage which is well below the conforming limit.
Apart from this, you can avail the second mortgage as a home equity line of credit. Once you pay off the line of credit, you can again withdraw cash from it till the loan period is over. But after taking 2 mortgages, most lenders will not approve you for an additional loan against your home equity. In addition, it is easier to qualify for a traditional mortgage with a PMI rather than with a piggyback loan. Lenders often demand a FICO score of 680 for the second loan and about 620 for the first mortgage and most borrowers fail to build up such scores.
Furthermore, some lenders may accept interest only payments on the second loan for a period of 10 to 15 years and then require you to pay the dues with balloon payments. Borrowers accepting such options often fail to make huge payments and end up refinancing the second loan, that too when market rates are high. But a loan with a PMI can help avoid such situations.
Considering the pros and cons of a piggyback mortgage, it is advisable that you choose a traditional mortgage loan along with the payments for private mortgage insurance. The premiums may not be tax deductible but it is better to pay those premiums rather than make interest payments on 2 mortgages and that too when the rate charged on the second loan is quite higher. The second loan in a piggyback mortgage is usually a variable rate loan; so in order to avoid higher interest rates, borrowers should preferably opt for a mortgage loan that requires PMI instead of a piggyback loan.