Will You Save Money with 100% Mortgage Financing, a Piggyback Home Loan?
Have you already decided to buy a home? The only remaining question: How should you finance it?
Let’s say you’re looking into a $400,000 with a 30-year fixed-rate mortgage. Perhaps you can afford a 20% down payment - but will you save money by keeping that cash tied up in investments?
Is it a better choice to look into 100% financing with a product such as an 80/20 piggyback home loan? Or should you take funds out of other areas and put them into a down payment along as part of a typical mortgage package? Let’s discuss these options.
Taking a 100 percent loan with a piggyback - a first mortgage for 80 percent of value and a second mortgage for 20 percent - would result in a higher overall cost than an 80 percent loan with a 20 percent down payment. In part, the higher cost will be in the higher rate on the second mortgage. But in addition, either the rate on the first mortgage will be higher, or the total loan fees will be higher.
The intent, in the scenario above, is to invest the $80,000 that would otherwise go into a down payment. But a down payment is also an investment.
The return consists of the reduction in upfront costs, lower interest payments in the future, and lower loan balances at the end of the period in which you expect to be in the house. Determine the annual rate of return on investment in the case cited above with a mortgage calculator, assuming you intended to be in the house for seven years. It was 15.6 percent before tax, and it carries no risk. Investments that good are not available in the marketplace.
Why is the return so high? When you take a 100 percent home purchase loan, even though you have the capacity to make a down payment, you place yourself in the same risk class as borrowers who have not been able to save for a down payment, those who have negative equity in their house the day they move in.
The default rate of such borrowers is relatively high; they pay for it in the price of the piggyback (or in mortgage insurance); and you pay the same price as them. This is a situation you should try to avoid if you can afford to do so.