It was a year of firsts: In 2015, Kristian and Michele Klein welcomed their first child, a daughter, and bought their first home — a freshly renovated four-bedroom Cape Codin Glen Head, New York.
But instead of making a traditional down payment of 20 percent — the magic amount often needed to avoid the added cost of mortgage insurance — they put down just 10 percent, still a significant sum, on their $685,000 house. Yet they managed to circumvent the insurance, saving more than $250 a month.
How did they do it? They took out one loan equal to 80 percent of the purchase price, and another loan for 10 percent — something that has traditionally been called a piggyback loan or a second mortgage.
With home prices on the rise in many parts of the country, coming up with 20 percent can seem an insurmountable task for prospective homeowners of all income levels. Last year, about 65 percent of all homebuyers — or 1.9 million borrowers — put down less than 20 percent, according to an analysis by Inside Mortgage Finance that covered about 80 percent of all mortgages and excluded jumbo loans.
While most lenders require mortgage insurance on loans with smaller down payments to compensate for their extra risk, there are several options that do not. A few new programs have become available post-recession, while some older strategies have been resurrected, including the piggyback loan. All let borrowers avoid the added monthly expense of insurance, which generally costs from 0.3 percent to more than 1 percent of the loan amount annually. But borrowers may pay a slightly higher interest rate instead.
Plenty of options
Avoiding mortgage insurance won’t always be possible. Nor will it always be the best or most economical decision. But the good news is that prospective homebuyers have options, whether through a traditional bank, a credit union or a newer alternative lender.
The Kleins said that having the extra cash on hand, rather than tied up in the house, gave them a stronger sense of security, particularly with a new baby.
“We would have some more wiggle room as opposed to giving and using all of your savings for the home,” said Kristian Klein, 34, who works for a consulting firm that represents publicly traded companies. “I would rather have the money in my pocket to work with.” The 20 percent down payment requirement is etched into the charters of both Fannie Mae and Freddie Mac, which back or purchase most mortgages in the United States up to $417,000 (or $625,500 in higher-cost areas). Homebuyers who want to borrow more than 80 percent need to buy insurance to protect the agencies, or another party must provide it for them.
Most commonly, the borrower pays the insurance in the form of a monthly premium, which must be automatically canceled once the mortgage balance reaches 78 percent of the home’s original value (though homeowners can petition to have it dropped once it reaches 80 percent). Mortgages from the Federal Housing Administration, however, continue to charge insurance for the life of the loan.
Alternatively, lenders may pay for the insurance, though that generally raises interest rates for the borrowers — perhaps by 0.375 to 0.5 percentage points, loan officers said, depending on the borrowers’ credit history, their down payment and other factors. The downside is that the rate is higher for the life of the loan, unless the borrower refinances.
A new program from Bank of America, in partnership with Freddie Mac and a group called Self-Help, avoids the insurance altogether, even though it permits down payments as low as 3 percent. But there are some significant limiting factors. Families in the New York area generally cannot earn more than $80,700, the area’s median income; the mortgage amount cannot exceed $417,000; and interest rates are marginally higher than those of traditional mortgages (but often better than other competing options).
At the opposite end of the spectrum is Social Finance, the lender known as SoFi, which got its start in student loans. Eligible homebuyers can put down as little as 10 percent on amounts of up to $3 million — without mortgage insurance — though those loans will command a slightly higher interest rate.
Other jumbo mortgage lenders, which generally make loans above Fannie’s and Freddie’s limits of $417,000, are also providing loans with slightly smaller down payments.
“Where we’ve seen the biggest change is in the appetite of jumbo lenders in the private sector to allow for 90 percent financing, which we hadn’t seen be this widespread since before the crash of 2007 to 2008,” said Mark Maimon, a vice president with Sterling National Bank in New York, which acts as a lender that can also work with other loan providers. Jumbo lenders sometimes require insurance, but not always, since they aren’t selling their loans to the government agencies. But they may require a marginally higher interest rate.
Then there are the thousands of credit unions across the country that have a little more leeway in offering low-down-payment loans without insurance, largely because they keep their loans on their own books.
“They can listen to the story of the borrower,” said Bill Hampel, chief economist and chief policy officer at the Credit Union National Association. “That doesn’t mean they make riskier loans, but they can balance loan requirements off one another. If they are weak in one category but strong in another,” the credit union can still make the loan, he said.
At CommunityAmerica Credit Union, in Lenexa, Kansas, for example, borrowers have several options. They can put 10 percent down using one loan without mortgage insurance, or they can take an initial mortgage for 80 percent of the purchase price and a second loan for up to 15 percent, similar to what the Klein family did. “We are going to run the scenarios,” said Carrie O’Connor, chief lending officer. “You need to look at each individual situation and evaluate it.”
The piggyback or second mortgage — not to be confused with the versions misused during the housing bubble, which permitted up to 100 percent financing — can take different forms. The second loan may be a home equity line of credit, which typically carries a variable rate that is based on the prime rate plus an additional margin set by the lender. It generally requires only interest-only payments, but adjusts to a principal and interest payment after 10 years. (Fixed-rate second mortgages, say over a 20-year term, may be also available, but rates are usually higher than the line of credit.) Using the line of credit can be a more economical option, even when factoring in principal payments. But the buyers need to be disciplined about paying down the principal. And there’s the risk of rising interest rates, which is a reason some loan officers suggest using this option as shorter-term financing.
“This is a great option for those borrowers that have high bonus or commission income who eventually want to pay off the second mortgage down the road and end up with just one mortgage,” said Deb Klein, a loan consultant at Caliber Home Loans in Chandler, Arizona. Or they may be waiting for their previous home to sell, which will free up cash to pay down the loan.
SoFi factors its costs into one interest rate and uses nontraditional means to vet borrowers, forgoing credit scores and instead looking at something in plain view: extra cash. SoFi requires income documentation for the last two years, and it reviews prospective borrowers’ debt load in relation to their ability to pay the debt under consideration. But SoFi likes to see at least $1,500 left over each month after all debts, including the mortgage, are paid. “We don’t focus so much on ratios as we do dollars of cushion,” said Mike Tannenbaum, who oversees SoFi’s mortgage business. “We underwrite mainly on free cash flow.” Nicole Armstrong, a corporate employment lawyer, and her husband, who works for a software services firm, recently purchased a three-bedroom white stucco home in the Easton Addition neighborhood of Burlingame, California, a costly market just outside San Francisco.
Although they have two healthy incomes, a good portion of their assets is locked up in privately held companies, so securing a jumbo loan for the home proved challenging. But SoFi — which Nicole Armstrong said she learned about from a billboard along Highway 101 — ultimately let the family make a down payment of 15 percent and charged a competitive interest rate of 3.75 percent. “It allowed us to put a little less down compared to what the market trend was,” she said. “And we didn’t need mortgage insurance.”