Definition, example, advantages and disadvantages, alternatives
- An 80/20 is a type of piggyback loan used to buy a home without using money for a down payment.
- You will get the financing in two parts — the first will be a traditional mortgage for 80% of your purchase price.
- The second part will be a home equity loan or HELOC, and you will use this to make a 20% down payment.
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Saving for a down payment on a house is a huge financial undertaking, often taking years. What do you do if you feel ready to buy a home, but you don’t have money set aside for a down payment? Taking out an 80/20 loan could be your solution.
What is an 80/20 loan?
An 80/20 loan is a type of piggyback loan, that is, a home loan that is split into two parts.
It’s called an 80/20 loan because the first part is a mortgage that covers 80% of the purchase price of the home. The second part is either a home equity loan or a home equity line of credit that covers the remaining 20%.
With an 80/20 loan, you don’t have money set aside for a down payment – which sets it apart from other types of piggyback loans. For example, with an 80-10-10 loan, the first mortgage is 80%, the second is 10%, and you already have 10% of the purchase price in cash for a down payment.
Not only does an 80/20 loan allow you to buy a home with no down payment, it also saves you from paying for private mortgage insurance, which is mandatory if you have less than 20% down. Having a large down payment is also a useful way to avoid applying for a jumbo mortgage, a type of large mortgage that charges higher interest rates.
Example of an 80/20 loan
Let’s compare a traditional mortgage with an 80/20 loan. In this example, you buy a house for $400,000, but you don’t have money for a down payment. You can either wait and save 3% for a down payment with a traditional mortgage – which is the minimum for a conventional mortgage – or take out an 80/20 loan now with no down payment.
With the 80/20 loan, you combine a 30-year mortgage with a 15-year home equity loan.
Here are the details of your monthly payments with each option, assuming the private mortgage insurance payment is 1% of your original mortgage amount each year.
In this example, the 80/20 loan would cost a little more each month, so you can opt for the traditional mortgage instead. The difference in monthly payments isn’t drastic, however, you may still decide it’s worth buying now instead of taking the time to save up for a down payment.
Keep in mind that this would only be your monthly payments for a traditional mortgage until you have acquired enough equity in your home that you no longer have to pay PMI. For the 80/20 loan, this would only be the payments until the end of the 15-year home equity loan, leaving you with only the remaining mortgage payments.
Advantages and disadvantages of an 80/20 loan
Because an 80/20 loan splits your financing into two parts, you can avoid a jumbo mortgage that would charge a higher interest rate. You can also avoid paying monthly for private mortgage insurance.
“Even if you have rates that are in the nines or tens on that second mortgage, that still represents a lower monthly payment and better use of your income, compared to paying insurance premiums that do nothing to you,” says Darrin Q English, Senior Community Development Loan Officer at Quontic Bank.
An 80/20 loan has additional expenses, however, including two mortgage payments and two sets of closing costs. It is also likely that the interest rate on your second loan will increase later since the rate will be adjustable.
“It’s unpredictable where rates will go, how the
going to raise rates, and what that’s going to do for an adjustable rate mortgage in the coming months,” says English.
Alternatives to the 80/20 loan
Of course, not everyone can get an 80/20 loan. To qualify, the English says you’ll likely need at least a 720 credit score and a debt-to-income ratio of 43% or less. If you don’t qualify, or just don’t want to make two payments a month, you may want to consider other options.
Save for a deposit
Although a 20% down payment eliminates the need for PMI, you do not need a 20% down payment to qualify for a mortgage. Many conventional mortgages only require a 3% down payment and you can get an FHA mortgage with a 3.5% down payment.
Find down payment assistance programs
You may be eligible for a program that gives you a loan or grant to pay a down payment. Sometimes you will get help directly through your lender. For example, Chase offers grants of up to $5,500 for low-income borrowers, and Bank of America offers a variety of options depending on where you live. There may also be down payment assistance programs through your state or local government.
Pay for private mortgage insurance
You can simply decide to pay for the PMI rather than take out an 80/20 loan, especially if the PMI would be cheaper than an 80/20 loan in your case.
Get a bridging loan
Sometimes piggyback loans are useful if you’re moving into a new home but your first one hasn’t sold yet. An 80/20 loan can help you buy a new home until your first home sells.
In this case, you can also consider a bridging loan. This is a home loan that helps you bridge the gap between when you buy your new home and when the finances of selling your original home kick in. You can usually borrow up to at 80% of the value of your original home, and the term is six months. at one year. Bridge loans can be attractive because their terms are shorter than a home equity loan or HELOC.
Your decision whether or not to get an 80/20 loan might depend on the cost of PMI or whether you qualify for a down payment assistance program or bridge loan.