Calculating the difference In Cost Between PMI and 80-10-10

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.

What is 80-10-10 Financing

80-10-10 kind of financing is quite common. This kind of financing applies for a borrower who cannot afford to make 20% down payment on his mortgage. Many people fit into this category even though they are high earning individuals. Unless you have practiced savings tactics, you could find it difficult to come up with plenty amount of cash equal to 20% to make the down payment.

Now what happens when you do not make that 20% magic figure? If you have read our previous sections you will know that if you do not make 20% of down payment you are most likely to be charged private mortgage insurance, PMI.

For this reason a new financing technique was involved which was known as the 80-10-10 financing. This financing helps you to come up with 20% of down payment where you only put 10% and pay the other 10% by taking a second mortgage. This allows you to circumvent the monthly PMI payment and also a higher rate of interest on your mortgage.

Do not get too hung up on the terminology when we say 80-10-10, as this could be in any other competition as well such as 80-15-5 which means that you only put down 5% down payment and gets the other 15% from your second mortgage.

This kind of financing also help to avoid a jumbo loan if the amount you are borrowing goes beyond the limitations set by Fannie Mae and Freddie Mac on conforming loans. If the amount you are borrowing on a first mortgage exceeds this amount you can use this method to break it down into first and second mortgage and thereby cut down your interest rate by up to .5%. This is so because interest rates on nonconforming loans and jumbo loans are usually higher than conforming loans.

Common Sources Of 80-10-10 Financing

From house sellers

People selling their homes offer a second mortgage either as marketing techniques to induce buyers or because they want to generate income from the loan. Many sellers, specially during the times when selling a home is difficult, offer financing to the borrower.

When the home owner carries a second mortgage it is generally less expensive than a second mortgage made by lending institutions such as banks and credit unions. Also most of the home sellers do not charge for loan origination fee. Seller second mortgages are nearly always short-term balloon mortgages that become due 3 to 5 years from the date of origination.

If you are getting sellers financing for a second mortgage lender for the first mortgage will probably want to review the terms and conditions of the second mortgage. The lender will need to be assured that the payment due on the second mortgage does not make the payment on the first mortgage difficult.

He should be assured that you are not overextending your finances and hence risk the foreclosure in the future.

From institutional lenders

You can get this kind of financing from the same institutional lender who makes you your first mortgage. The terms and conditions will differ from one lender to another. Some mortgage lenders will structure the second mortgage as home equity loan whereas others may offer the conventional second mortgage.

The second mortgage may be a fixed-rate mortgage or an adjustable rate mortgage with a balloon payment. Most of the times second mortgages are adjustable rate mortgages.

If the second mortgage is fully amortized it is usually structured as a 15 year mortgage. As mentioned before, 80-10-10 financing can be structured in any format such as 80-5-15 or 80-15-5.

The lesser down payment you make the more of a risk the lender is taking in giving you a mortgage. So an 80-15-5 will have a higher interest rate and origination fee than a 80-10-10 financing because you are only paying 5% down payment. Also, 80-10-10 will have a higher interest rate as compared to traditional mortgage on which you make a 20% down payment.