80 20 Mortgage

Traditionally, one of the reasons it is advantageous to come up with a 20% or more down payment when purchasing a home is that anything less than that requires you to pay for private mortgage insurance (PMI), which can be quite expensive.

Ironically, the home buyer buys the insurance, but the insurance in fact is to protect the lender.  The insurance is to cover the costs of eventually having to foreclose on the house.  The buyer in effect is making it more attractive to lend him or her money by saying, “Look, even if I can’t pay and you have to kick me out, at least it won’t cost you anything to do so.”

But people have devised ways to avoid having to come up with 20% of the purchase price as a down payment, and yet not have to buy PMI.  One of the ways to do this is known as an “80-20 mortgage.”

An 80-20 mortgage is a way to make a down payment of zero, and yet have it count as 20%.  The way it works, the buyer takes out a loan for 80%, the same as if he or she were going to make a down payment of 20%, thus obviating the need for PMI.  They then take out a second, separate, loan for 20%.  In effect they’re borrowing their down payment.

So all of the money for the purchase price is borrowed, but because they borrowed 80% and 20% separately rather than taking out one loan for 100%, they get around the PMI requirement.

Besides the PMI advantage, like any no down payment deal there is the advantage of not having to come up with any money to buy a house.  (Though there will still be closing costs beyond the purchase price that the buyer will have to pay.)

Certainly there are disadvantages too, of course.  For one thing, the terms on the 20% loan tend to be fairly unfavorable.  Whether the difference is enough to outweigh the amount saved on PMI compared to borrowing 100% in one shot would have to be determined on a case-by-case basis.

Also, borrowing 100% of the purchase price increases the risk one will at some point be “upside down” on the house.  That is, if home values dip, the owner may owe more on the house than it’s worth, and so in a crunch will not have any equity in the house to borrow off of.

Still, it may be the best deal available for certain buyers in certain circumstances.  Not necessarily just those who lack the funds to make a 20% down payment, but also those who maybe have their money invested in ways they prefer not to liquidate.

There are also variants of this mortgage type for people who are willing and able to make a down payment, but for less than 20%.  In that case, the second, more disadvantageous, loan amount is reduced.

For instance, an 80-10-10 mortgage is one with a conventional loan for 80%, an additional loan for 10%, and a down payment of 10%.  An 80-15-5 mortgage is one with a conventional loan for 80%, an additional loan for 15%, and a down payment of 5%.