Stretching yourself financially to purchase a home is usually a bad idea. (How bad? These types of purchases helped fuel the housing bust of just a few years ago.)
However, in some occasions you can stretch yourself for just a while, quickly pay off any financial problems that crop up, and come out ahead. Let’s say you found an amazing deal on a fantastic house, but don’t quite have the down-payment you need. Instead of missing out on the home entirely, you can take on an 80-10-10 mortgage to help finance the home.
What is an 80-10-10 mortgage and how does it differ from other mortgages? Let’s look at the details.
How Does an 80-10-10 Mortgage Work?
In a traditional mortgage a buyer will bring 20% of the home’s cost as a down payment while the bank or credit union finances the remaining 80%. These 80-20 loans (or 80% Loan-to-Value loans) is the standard in the mortgage world.
The mortgage industry has been creative in coming up with new alternatives to help buyers find homes: 5-in-1 ARMs, interest-only loans, and 40-year mortgages. Most of these adaptations are bad choices in the long run, but the 80-10-10 is in a gray area.
With an 80-10-10 mortgage the buyer brings 10% to the table as a down payment rather than 20%. The extra 10% of down payment needed comes in the form of a second mortgage that is originated at the same time as the first mortgage. Normally this second mortgage will come from the same financing company, too.
The second mortgage comes with a higher interest rate (otherwise it would just be like having a larger 1st mortgage). For example, if you are buying a $200,000 home with this type of mortgage you would bring $20,000 as your down payment. $160,000 — 80% of the value of the home — would come from a first mortgage a 3.25%. The remaining $20k — the last 10% needed — would come from a second mortgage at 4.75%.
Note: These rates are examples. Here is a list of current mortgage rates.
80-10-10 Mortgage vs. Private Mortgage Insurance
Using an 80-10-10 mortgage helps buyers avoid paying Private Mortgage Insurance or PMI. If you buy a home using PMI your first mortgage would cover the entire value of the home besides your down payment. (In the above example your first mortgage would be 90% or $180,000 and you would have a $20,000 down payment). This would keep your interest rate overall lower than if you had a second mortgage. However, to protect the bank from the increased risk of default from the larger loan (and really, higher loan to value) they require you to purchase PMI.
Is PMI a better option than an 80-10-10 mortgage? It really depends on your personal situation. PMI can be useful if you anticipate your home value increasing faster than you would be able to pay off the second mortgage. If your home goes up enough in value to cover that extra 10% you had to borrow, you can cancel PMI. (Your Loan-to-Value needs to be at 80% or less for you to cancel PMI.)
However, in the current real estate market there are not many markets where that type of price appreciation can be expected. In this case, it can make sense to get a second mortgage with an 80-10-10 mortgage and aggressively pay off the loan.