Home buyers may now need to pull out their calculators when tackling a common question: what to do if they don't have enough money for a 20 percent down payment.
In recent years, piggyback loans, low-cost and easy to get, have been the product of choice for many cash-strapped consumers eager to purchase homes. But with short-term interest rates now sharply higher -- above 8 percent -- piggyback loans are less appealing. Now, there are signs that some borrowers are giving traditional private mortgage insurance a second look.
New federal tax law gives some consumers even more reason to turn to mortgage insurance. The new law makes the insurance premiums tax-deductible for some borrowers who take out new mortgage-insurance contracts in 2007. That is in addition to the tax deduction homeowners can already take on the mortgage interest they pay.
What's more, new guidelines issued recently by bank regulators could make it tougher for some borrowers to get piggyback loans, particularly if these are paired with exotic types of mortgages that may increase risk. Some lenders have already seen higher delinquency rates on piggyback mortgages.
For borrowers, whether a piggyback loan or mortgage insurance makes more sense is likely to depend on interest rates, as well as an individual's borrowing needs. "When rates were very low, there was no question that a . . . piggyback was more economical for consumers," said Doreen Woo Ho, who runs the home-equity business for Wells Fargo. Now, she says, the two options are "more competitive."
With a piggyback loan, a borrower takes out a mortgage for 80 percent of the home's value and finances the balance of the debt with a fixed-rate home-equity loan or a home-equity line of credit, allowing the consumer to borrow as much as 100 percent of a home's purchase price. Piggybacks were particularly attractive when short-term interest rates were at rock-bottom levels. As recently as 2004, borrowers could get home-equity lines of credit with rates as low as 4 percent, well below the rate on their main mortgage. In addition, interest on home-equity loans and lines is typically tax-deductible.
With mortgage insurance, a borrower with less than 20 percent to put down takes out a single loan and pays a mortgage-insurance premium that can vary based on the amount the borrower puts down, credit history and other factors. For a $225,000 mortgage, for example, the insurance premium could run from $50 to $100 a month. (In some cases, the lender pays the mortgage-insurance premium and charges the borrower a slightly higher interest rate.) Lenders require mortgage insurance because borrowers who put little, if any, money down are more likely to default.
Mortgage-insurance providers are expecting business to pick up in the wake of the tax-law change, which they had lobbied for. Mortgage Insurance Companies of America, a trade group, is spending $1.1 million on an advertising campaign aimed at mortgage brokers and real estate agents. Genworth Financial, a leading mortgage insurer, is running "webinars" to explain the implications of the new law. PMI Group is sending out 15,000 foam oranges with stickers saying mortgage insurance is now deductible.
Mortgage lenders are also rethinking their strategies. J.P. Morgan Chase is looking at how to help its loan officers understand the new rules and decide whether mortgage insurance or a piggyback will be a better bet for borrowers. "There's a whole generation of mortgage brokers who have not seen or sold mortgage insurance," said Thomas Kelly, a J.P. Morgan Chase spokesman.
The new tax legislation makes premiums fully deductible for borrowers who take out a new mortgage-insurance contract in 2007, provided that they have $100,000 or less of adjusted gross income ($50,000 if married and filing separate returns). The deduction phases out for borrowers with incomes between $100,000 and $109,000. The deduction applies to insurance on mortgages taken out to buy homes and on refinancings, provided that the new loan isn't for more than the amount of mortgage debt being refinanced. To claim the deduction, borrowers must file an itemized tax return. Unless the law is extended, the tax break will expire at the end of 2007.
Borrowers who took out piggybacks in recent years have seen the rate on their home-equity lines increase by as much as four percentage points. Now some borrowers whose adjustable-rate mortgages are resetting choose mortgage insurance instead of a piggyback when they refinance, said Michael Zimmerman, vice president of investor relations for MGIC, an insurer.
Consumers should compare the monthly payments on a piggyback vs. mortgage insurance. If the rate on the home-equity line is more than two percentage points above the rate on your primary mortgage, "you should be strongly considering a mortgage-insurance policy," said Keith Gumbinger, a mortgage analyst with HSH Associates. "But you need to run the numbers."
HSH offers a calculator (
The size of the piggyback loan can also make a difference. "If you are taking out a $400,000 first mortgage and a $30,000 or $40,000 [home-equity loan] . . . it still may make sense to pay a little higher rate on $30,000 or $40,000, rather than paying mortgage insurance on the whole $430,000," said Dan Arrigoni, president of U.S. Bank Home Mortgage, a unit of U.S. Bancorp. In an effort to keep loan volumes up, some lenders are offering special deals that make piggybacks attractive to borrowers with good credit even as short-term rates move higher.
Another factor to consider: how fast you expect to pay down your mortgage. Since 1999, mortgage insurers have been required to automatically cancel the premium when a homeowner has paid down the mortgage to 78 percent of the original purchase price. Also, homeowners can ask their lender to stop premium charges if rising home prices and monthly mortgage payments bring their loan amount to 80 percent or less of the home's value.
"It may involve springing for an appraisal, but that can quickly pay for itself," said Greg McBride, a senior financial analyst with Bankrate.com. Homeowners selecting this route should use an appraiser who has been approved by their lender, he added.