Interesting Q&A going on over at Inman News:
Q: “We are purchasing a $400,000 home that we want to finance with a 30-year fixed-rate mortgage. While we can more than afford the cost of a 20 percent down payment, I would prefer to keep my money in my investments instead. I was thinking of financing 100 percent (using an 80/20 to get out of paying PMI) but was unsure whether this type of loan structure would result in a higher interest rate on the first mortgage?”
A: 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.
To illustrate, on Oct. 17 I shopped for a purchase loan on a $400,000 property in California. If I put down 20 percent, I could get a 30-year, $320,000 fixed-rate mortgage at 5.75 percent, 1/2 point, and other lender fees of $4,770. If I went 100 percent and kept the first mortgage rate at 5.75 percent, the rate on the second mortgage of $80,000 was 8.15 percent, total points were 1.5, and other fees were $6,490.
Your intent 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. I calculated the annual rate of return on investment in the case cited above, 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 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, and 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.
You wouldn’t have your 17-year-old son purchase automobile insurance for your car. You wouldn’t buy life insurance and tell the insurer you are 10 years older than you really are. You shouldn’t take a 100 percent mortgage loan when you can afford to put 20 percent down.
Benjamin Bach is a Real Estate Consultant with Keller Williams Golden Triangle Realty in Kitchener Waterloo. He voraciously tracks the Real Estate market so that he can fulfill his mission of building wealth for his clients through smart Real Estate investments, and helping people achieve success. If you are interested in how you can start your Real Estate portfolio, or have any questions about buying a home or selling a home, you can email Benjamin (benjamin AT benjaminbach.com) or reach him at 519 772 4376.