Avoiding PMI through piggy backing
Investors want the highest possible return on their investment; this is the goal and mark of a successful endeavor. After all, low monthly payments equate to a higher cash flow. And the higher cash flow, the higher the return on your investment. But then delightful little fees and payments begin to sneak into the equation, and pretty soon you’re hardly breaking even or even taking a monthly loss. While in some cases a slightly negative cash flow is tolerable (long-term investments with high appreciation, for example), many investors try to avoid a negative cash flow.
One fee that bites into monthly cash flow is PMI or Private Mortgage Insurance. This typically affects investors who borrow more than 80% of the property’s sales price. You see, in the eyes of a lender, such borrowers are relatively risky. To offset risk, the lender charges a fee, PMI, which covers the bank if the borrower defaults on their loan. This insurance, charged to the entire loan amount, can be as high as 1.5%–depending on loan type and down payment amount.
However, there is a way–called piggy backing–to avoid paying this particular fee. Many lenders offer “piggy back” loans, which are loans where two separate mortgages are lumped together. It goes like this: A mortgage is assigned, with market interest rates, for 80% of the sales price. But the borrower requires more money so a second loan is also taken out to cover the remaining needed funds. This second loan is called the piggy back loan, and the interest on this smaller loan is much higher than the first because it is the last lien to receive funds if the borrower defaults. What makes piggy back loans so attractive is that the higher interest is only charged to the smaller loan.
Piggy backing works well for many and can lead to significant savings. But really do your research here, because piggy backing is not always the right option for every investment. In some cases PMI payments are relatively small and will cost less than the high interest associated with piggy back loans. Now, if you do the math and see that both the PMI payments and the piggy back payments are incredibly high, it’s probably time to revisit your strategy and consider making a larger down payment if possible.