Over the years, lenders loosened requirements for borrowers looking to obtain a mortgage. The 80/20 loan, also referred to as a piggyback mortgage, became a popular way to obtain a traditional 30-year fixed mortgage without having any money to use as a down payment. This loan also is used to avoid paying private mortgage insurance.

Definition of an 80/20 Loan

When a borrower has no money for a down payment but desires a traditional fixed-rate mortgage, he or she can use an 80/20 loan. Often, an adjustable rate mortgage or other sub-prime mortgage would be offered in this case, since the borrower is a risk to the lender. Essentially, two loans are taken out simultaneously for the same home. The first loan is 80 percent of the value of the mortgage. This is the primary loan and will have the better interest rate. The second loan will be for 20 percent of the value of the mortgage. This will be at a higher interest rate than the first. This may be with the same lender, but often it is obtained through a second lender. The interest rate will be higher since the second lender is in second position if you foreclose. The second lender may not regain any assets in the event of a foreclosure after the first lender has taken its share.

Private Mortgage Insurance

Some 80/20 loans are obtained to avoid private mortgage insurance(PMI). Because the borrower put up no cash to the lender, he or she is seen as a possible risk. Therefore, his or her mortgage is insured so the lender protects itself in the case of foreclosure. PMI is only necessary for loans over 80 percent of the value of the home.

There are two ways to avoid paying PMI: an 80/20 loan or a 20 percent down payment. The first loan, at 80 percent, will not require PMI because there is already 20 percent equity in the home. The second mortgage of 20 percent never requires PMI. Therefore, you are able to completely avoid it by taking out this type of loan.

Pros and Cons of an 80/20 Loan

There are several positives of an 80/20 loan. You are able to obtain a mortgage without much cash in hand. You save money by not paying private mortgage insurance. And you are able to receive a conventional loan at a decent rate, instead of taking a sub-prime loan at a higher rate due to the lack of a down payment.

There are negatives involved too. For one, you are taking out a loan you possibly couldn't afford. You are paying a higher rate on the second mortgage, which will cost you thousands over the life of the loan. And you are entering into a home with no immediate equity, as opposed to 10 or 20 percent equity if there had been a down payment.

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