Between 2000 and 2006, and still an option for many buyers, a popular idea was to take out a second mortgage on their home purchase. The first loan was almost always for 80% of the sales price of the home, and the second loan would be between 5% to 20% of the sales price, which would then require a down payment of between 0% and 15%.
The purpose of taking a second loan is to eliminate Private Mortgage Insurance (PMI), which is designed to afford lenders insurance protection in the event a buyer defaults on a loan that has a single mortgage of more than 80% of the home's value. For example, if a buyer makes a $10,000 down payment on a home purchased for $200,000, the lender would be at risk for 95% of the home's value. In this situation, the lender will usually require the buyer to purchase PMI, which has a typical cost of .75% (.00075) of the loan amount, or on the $190,000 loan referenced above, the buyer's monthly fee for the PMI would be approximately $142.50.
The second loan idea, which by satisfying the lender's requirement of an 80% loan, relieves the buyer of the PMI fee. Of course, there's a catch to the process. Almost always, except in some privately obtained second loans, the interest rate on the second loan will be considerably higher than the rate on the first lien. If the rate is so high that it offsets the advantage of executing the second loan, then the buyer would be better off paying the PMI fee.
Many analysts are now saying that because of the higher rates, the second loan idea is no longer a valid option. My opinion is that each situtation warrants its own evaluation. One aspect of the comparison that should always be considered is that with the second lien type loan, the balance is decreasing with each monthly payment. Conversely, on the PMI insurance, which will remain as part of the loan payment until the mortgage is reduced to 80% of the sales price, none of that amount goes toward the principal of the loan.
Still, you should consider all variables. For an individual consultation, please call me at (210)681-5252.