In order to calculate the benefit of using 80-10-10 financing as opposed to making only 10% down payment and taking a private mortgage insurance, let us take this example of a $200,000 home loan on which you make a 10% down payment.
Cost with private mortgage insurance
When you make only 10% down payment on the above-mentioned loan and get a loan for 90% of the purchase price on a 30 year fixed-rate mortgage with an 8% interest rate, your monthly payment is $1322. The Pvt. mortgage insurance will cost you an additional $70 per month which is not tax-deductible. This makes a total mortgage monthly payment equal to $1400.
Cost with Second Mortgage 80-10-10 Finance
Owner carry second mortgage
If you go for a second mortgage which has been financed by the owner, the calculations of your monthly mortgage payment is going to be slightly different. Let us say you find a seller who will carry a 10% or $20,000 fixed rate second mortgage on the same loan as above. The second mortgage is amortized on a 30 year term. However, as most owners carry second mortgages are short-term mortgages, the loan is due in five years. The seller charges you a 7.5 interest on this mortgage and your payment is $140,. With a 10% down and a 10% second mortgage you only need to pick the first mortgage for 80% of the home value which will come to $160,000 on a 30 year fixed-rate mortgage at 8%. The mortgage payment for this first mortgage will come to $1175 per month. By adding the $140 payment for second mortgage your monthly payment on the home loan will be $1315 which is $85 less than the example above using the private mortgage exam example. The interest on both the first and second mortgage will be tax-deductible. Another advantage is that you can probably pay off the second owner carried mortgage anytime you want whereas the private mortgage insurance can be a little more difficult to get rid of.
The only disadvantage is that the second mortgage is going to be due after five years and you will need to pay back the entire money due on the loan. You’ll be disappointed to discover that because of the amortization schedule almost 94.6% of your original $20,000 that the borrower owner lent you remains to be paid. This is in spite of having made a payment of hundred $40 regularly for 60 months. At this point, many people expect to refinance the second mortgage. However, what if for some reason you cannot refinance it due to a change in financial conditions such as losing your job or the value of the property decreasing? The interest rate on the mortgages could also become a much higher which will make it difficult for you to qualify for a new loan. In this situation the balloon payment on second mortgage could very well destroy your mortgage payment schedule. This is the kind of situation which was referred to when we mentioned that balloon payment loans are also referred to as bullet loans by many mortgage lenders.
In fact balloon mortgages were one of the toxic mortgage loans that resulted in so many foreclosures when the real estate industry crashed in the late 2000s.
Second Mortgage from an Institutional Lender
In this example we consider the same home loan as above but the second mortgage is given by the institutional lenders and not by the seller of the home. You get $160,000 loan at 8% for 30 years as a first mortgage which will cost you $1175 per month. Since you’re dealing with institutional lender, you might get a few options regarding your second mortgage. He might offer you a second mortgage of $20,000, 10%, either as a fixed-rate mortgage, amortized over 30 years but due in 15 as a balloon payment or a fully amortized fixed-rate 15 year loan. You would pay $191 per month for the 30 year fixed-rate mortgage balloon loan with an 11% interest rate versus $225 a month for a 15 year fixed-rate mortgage at 10.75% interest. By examining both these options closely we can see which would cost you less. You would pay $1366 per month for the 15 year balloon payment loan. This mortgage will have a payment of $16,760 due in 15 years. By taking the fully amortized second option you increase your monthly payment by $34 to a nice round $1400 per month. You would also build up equity faster with that second mortgage and there is no balloon payment to worry about. For many people this kind of pressure and eventuality could be the reason why they would prefer to have a second mortgage without a balloon payment looming up. Either of these options from an institutional lender would be preferable to an owner carry second mortgage where a balloon payment will be due in just five years of time. This could become a problem for many homeowners if any emergency or change in financial situation towards the worse were to take place.
The choice between these two options is entirely yours and will depend upon whether you intend it to re-financed the second mortgage as soon as possible to a lower rate. In many situations home borrowers pay off the second mortgage much sooner than 15 years.