You’re contacted by a potential mortgage applicant who wants to buy a home. While interviewing her, she shares that she only has 5% to use towards a down payment. “Ok,” you think. “Conventional financing or FHA could work.” You schedule an appointment to get together the following morning.
The next morning the two of you meet and, much to her (and your) dismay, with just a 5% down payment, her debt-to-income (DTI) ratios are higher than she can afford and for which she can qualify. So what do you do now? Part ways? Hopefully not! How would you, the “Mortgage Doctor,” produce a strategy to help this client afford and qualify for the mortgage payment associated with the home and financing that she wants? Piggyback financing just might be the perfect answer!
It would be reasonable for a mortgage loan associated with a $200,000 purchase and a 5% down payment to result in a monthly private mortgage insurance (PMI) premium of $134.60. And that’s $134.60 that does nothing for the borrower aside from allowing her to secure a conventional mortgage loan with less than a 20% down payment. Through piggyback financing, however, even though there would be a second mortgage payment, the second mortgage payment, plus the lower first mortgage payment, could easily lower the applicant’s DTI ratios making the transaction more affordable and easier for which to qualify.
Here’s how this works. Piggyback financing scenarios are described by three numbers each separated by a forward slash. The first number represents the first mortgage’s loan-to-value (LTV). The second number represents the second (supplemental) loan’s LTV. The third number represents the percentage of the borrower’s down payment. As such, through a piggyback loan scenario by which the customer puts 5% down, the piggyback loan could be structured as an 80/15/5, a 75/20/5, or through any other combination as long as the first mortgage’s LTV is at or below 80% and all three numbers add up to 100%.
Through piggyback financing, the borrower pursues a first mortgage with an LTV at or below 80%. As such, PMI is not required. Since the borrower’s down payment does not completely supplement the difference between the property’s purchase price and the first mortgage (purchase price – down payment = loan amount), a second mortgage is needed to complete the picture. But, in consideration of the lower first mortgage amount combined with the second mortgage’s principal and interest (P&I) payment, the borrower’s qualifying ratio and total monthly expenditure would typically be lower than if he or she settled on a loan containing PMI.
Let’s consider the following example:
A borrower desires to purchase a home for $350,000 and put 5% down. Assuming an interest rate of 5% fixed on a 30-year note, the P&I payment amount, corresponding to the $332,500 loan amount, would be $1,784.93. Now add to that the monthly PMI premium of $235.52 (assuming a PMI factor of 0.85%), and the total monthly expense, not counting taxes and insurance (T&I), amounts to $2,020.45.
If the mortgage loan originator (MLO) were to instead suggest an 80/15/5 piggyback transaction, the first mortgage’s loan amount would be $280,000 ($350,000 x 80%) corresponding to a monthly P&I payment of $1,503.10. The borrower would then secure a 30-year, second mortgage for $52,500 ($350,000 x 15%) and, assuming that the second mortgage loan’s interest rate was 7%, its corresponding payment would be $349.28. Since, by doing this, there would be no PMI, the borrower’s monthly mortgage expenditure would now amount to $1,852.38 ($1,503.10 + $349.28) which is $168.07 lower than what the borrower would have paid with a straight 5% down, 95% LTV mortgage with PMI.
Another benefit associated with piggyback financing is rapid equity growth. By remitting the $1,852.38 total monthly P&I payment amount, as described in the aforementioned scenario, each of those payments contribute towards the borrower’s total equity position. When a borrower pays PMI, all of that PMI premium goes to the PMI insurance company with nothing increasing the borrower’s equity.
The primary challenge with piggyback financing is locating a lender from which to secure the supplemental mortgage loan. There are, however, lenders that still offer them so, with minimal effort, you should be able to find a home for your borrower’s second loan.
Financed Mortgage Insurance (FMI)
Financed Mortgage Insurance (FMI) is another arrow that every mortgage loan originator should keep in his or her quiver. Through FMI, by investing 10% down on a purchase transaction, the borrower avoids paying monthly PMI by financing a one-time PMI premium directly into his or her loan amount. By doing this, not only does the borrower avoid paying a monthly PMI premium, he or she pays more interest (due to the higher loan amount) which may result in a greater income tax deduction. Additionally, the borrower incurs a lower monthly payment expense than he or she would have if his or her loan contained a monthly PMI premium or a secondary loan payment. Lastly, if the borrower were to refinance or fully repay his or her mortgage within the loan’s first seven years, he or she might be entitled to a pro-rated refund of the financed mortgage insurance premium.
Let’s consider the following example:
A borrower wants to purchase a home for $350,000 and put 10% down. Doing so would result in a mortgage amount of $315,000 and a monthly P&I payment of $1,690.99 assuming a 5%, 30-year-fixed interest rate. With an approximate monthly PMI payment of $136.50 (considering a 0.52% PMI factor), the borrower would be spending $1,827.49 plus T&I every month.
If, however, the borrower took out a loan amount of $322,875 that includes a 2.5% Financed Mortgage Insurance premium, the total payment amount, based on the higher loan amount but without monthly PMI, would amount to $1,733.26 plus T&I. This represents a $94.23 monthly savings. And this doesn’t even include any potential income tax savings that the borrower might realize due to the higher loan amount in the event that the mortgage interest that he or she pays is tax deductible.
Just as you would expect your physician to accurately and appropriately diagnose your illness or injury and prescribe the best possible course of treatment, the mortgage loan originator is only as successful as his or her knowledge and creativity allows him or her to be. When I was a practicing loan originator, selling loans with FMI set me apart from my competition. Any time I encountered a mortgage customer who was buying a home with 10% down, I knew that I secured another loan. How? Because since very few of my colleagues and competition took the time to learn about FMI, I was, just about every time, the first MLO to discuss FMI options with the borrower. In fact, I was the only MLO at my company to use it. How did I know that? Because I had to instruct the underwriters as to how it worked!
Knowing all available options allows you to offer solutions that best fit your customers’ wants and needs. Knowing about and using piggyback financing and Financed Mortgage Insurance, when warranted, will help propel you to even greater levels of success.