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80/10/10 & 80/15/5
Piggy-back Combinations.
Although they are a common
practice now, Coastal Mortgage was an innovator in the industry in using a 1st
mortgage at an 80% loan-to-value combined with a 2nd mortgage at a 10% or 15%
loan-to-value to lower down payments AND escape having to pay private mortgage
insurance (PMI).
The concept is simple enough.
Since the 1st mortgage loan amount is 80%, there is no requirement to cover the
loan with PMI. The 2nd mortgage fills in the gap between 80% up to 90% or
95% loan-to-value so that our client only has to put 5% or 10% down. The
2nd mortgage can be structured as either a Home Equity Line of Credit (HELOC) or
a fixed rate 2nd mortgage with a 15, 20 , or 30 year due in 15 year term.
While there are clear
advantages for borrowers to employ an 80/10/10 or an 80/15/5 combination,
there are some basic consideration to think about to make sure the 80/10/10 or
80/15/5 structure is right for your situation. In other words,
coming out
ahead depends on many other factors. These include:
Interest rate on the second mortgage relative to the rate
on the first:
The
smaller the difference in rate between the two mortgages, the greater the
advantage of the combination relative to the single loan.
Term on the
second mortgage relative to the term on the first:
Shorter term loans pay down the balance faster than longer term loans.
Since the second mortgage has a higher rate than the first, the faster the
second is paid off relative to the first, the greater the advantage of the
combination compared to the single loan.
Your tax bracket:
Because the
combination loan enjoys a larger tax write-off, the combination is most
advantageous for borrowers in the highest tax bracket.
Closing costs:
With one
loan closing, closing costs should be the same for one loan or two. But
if the second mortgage is from a different source and requires a separate
closing, the combination will have higher closing costs.
Expected appreciation rate:
Borrowers
can request that their mortgage insurance be terminated when the loan
balance reaches 80% of the homes appreciated value. This means that
the higher the expected appreciation rate, the less the advantage of the
combination.
Other factors:
How long
you expect to remain in the home and the rate of return you can earn on
investments also affect how your choices shake out.
Consider a borrower purchasing a $200,000 house who plans
on remaining there for five years, and earns 5% on investments.
Example 1
assumes the borrower is in the highest income tax bracket (39.6%), expects
only 1.25% appreciation on his home, and is shopping the market on July
29, 2000. He compares a 30-year first mortgage for $180,000
(10% down) at 8.25%, zero points, and mortgage insurance of .52%, with a
combination of the same loan for $160,000 but no mortgage insurance plus a
15-year second mortgage for $20,000 at 11.75% and zero points.
Closing costs are the same.
Over the 5 years, the breakeven rate for the second
mortgage is 20.29% -- well above the market rate on a second. The
combination is a clear winner.
Example 2
is the same except that the borrower is assumed to be in the 15% tax
bracket. The breakeven rate on the second drops to 16.97%, but the
combination remains the better deal.
Example 3
is the same as example 2 but the first mortgage has a 15 year term.
The breakeven rate drops to 11.38%, slightly below the market rate on the
second. The borrower is slightly better off with one mortgage.
Example 4
is the same as example 3, except that the borrower expects his house to
appreciate at 5% a year, which makes possible early mortgage insurance
termination. The breakeven rate drops to 10.10%, which is well
below the market rate on the second. The borrower does significantly
better with one mortgage.
Example 5
is the same as 4, except that the borrower must pay an additional $1,000
in closing costs on the combination loan. The breakeven rate drops
to 8.68%, which makes the single mortgage more attractive yet.
In general, combination loans are least attractive
to low tax bracket borrowers who take out short-term first mortgages,
expect early termination of mortgage insurance, and face additional
closing costs on combination loans.
Angie McCarter
Contact me for more info
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