Financing MI on a 90% Loan Versus the 80-10-10
/For many years, borrowers have been able to put down 10% and avoid mortgage insurance (MI) by doing a piggyback loan, or an 80-10-10, where there is a 10% down payment and a 10% second mortgage to go with an 80% first mortgage. But now that Fannie and Freddie have increased pricing for the combo route, there isn’t as much benefit as there used to be with the combo. Assuming we are talking about a borrower with a great credit score (740 or above), there is a .75 bump to the points (which is the equivalent of .125-.25% in rate) when doing a combo. The cost to pay the MI up-front on a 90% loan is 1.29 points, or a bump to the rate of .25-.375%.
So here is an example: Sales Price is $250,000 and borrower has 10% to put down. For example purposes, we’ll say that the rate would have been 4.25% for this same customer if he/she had 20% to put down. Option 1 is to do the 80-10-10. The rate would be 4.5% on the first mortgage and probably prime plus 1.5% on the second (a home equity line of credit with interest only payments and prime is at 3.25%). Option 2 would be to do a straight 90% loan paying the MI up-front, but building it into the rate, which would be 4.625% in this example.
- Option 1 (80-10-10): P&I - $1,013 plus payment for second mortgage of $99 (interest only at prime plus 1.5%); Total: $1,112
- Option 2 (financed MI): P&I: $1,157
So the 80-10-10 still offers a better payment solution in this example ($45 per month cheaper). But it also means that $25,000 of the total money borrowed is on a fluctuating rate (subject to change with prime) and interest only is being paid. Versus Option 2 where the total amount of the loan is fixed, so no adjustments to worry about, and principal is being paid towards the entire balance. We still use the 80-10-10 regularly, particularly for clients that plan on making significant principal reductions to the second mortgage over the short term. But doing the deal with the straight 90% loan, financing the MI, probably makes more sense if the borrower has no intentions of paying extra. We will counsel the borrower on which one makes the most sense for the specific situation.
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The Week Ahead
This week, investors will continue to monitor events in Europe and the Middle East. The biggest US economic report will be Retail Sales, which will be released on Tuesday. Retail Sales account for about 70% of economic activity. The Producer Price Index (PPI) focuses on the increase in prices of "intermediate" goods used by companies to produce finished products and will come out on Wednesday. Industrial Production and NAHB Housing also will be released on Wednesday. Housing Starts and Philly Fed will round out the schedule on Thursday.
The Week That Was
Unexpected events outside the US had the greatest influence on mortgage rates last week. Violence in the Middle East and economic concerns about Europe caused investors to shift to safer assets, helping mortgage rates. Bond friendly comments from the Fed added to the improvement, and mortgage rates ended the week lower.
During periods of uncertainty, investors commonly reduce the risk in their portfolios. Generally, they shift from riskier assets such as stocks to relatively safer assets such as gold or US guaranteed bonds, including mortgage-backed securities (MBS). Added demand for MBS helped mortgage rates to improve last week as investors were confronted with concerns on two fronts. Violence in Israel caused tensions in the Middle East to increase. In addition, there were signs that the largest bank in Portugal may default on its debt. This caused investors to question the level of reserves held by the banks in Europe and the outlook for economic growth in the region.
The news from the Fed last week also was favorable for mortgage rates. There were no big surprises in the FOMC Minutes from the June 18 Fed Meeting and no new guidance on the timing of the first fed funds rate hike. The positive news for mortgage rates came as the Fed provided a little more detail on its plans for its mortgage-backed securities (MBS) portfolio. The Fed's portfolio has been growing at a scheduled pace as the Fed has been reinvesting principal payments received and adding new MBS. The Minutes indicated that the purchases of new MBS will end in October as expected. After that time, the Fed plans to continue to reinvest principal payments received, which will hold the size of its portfolio steady, at least until the first fed funds rate hike. Principal payments have been averaging $16 billion per month, so investors were pleased that the reinvestment will continue for quite a while, as the added demand for MBS helps keep mortgage rates low.