Saving enough money to make a down payment on a home is at times the most difficult task that would-be homeowners face, and one that often prevents people from getting their dream homes. Even putting away the bare minimum of 3% down can be an insurmountable obstacle for some. For many of these folks, an 80/20 piggyback loan may be the solution. Let’s look at how one can buy a home with zero money down with an 80/20 mortgage.
What exactly is an 80/20 mortgage?
When you use an 80/20 mortgage to buy a home with no money down, you’re making one purchase with two separate loans. The first loan goes toward 80% of a house’s selling price; the second, as you may have guessed, is used to cover the remaining 20% of the home’s cost. The first is a traditional mortgage loan, often with a 30-year term at a fixed interest rate. The second loan is usually either a 15-year home equity line of credit or a similar home equity loan, often with a variable interest rate.
When closing on an 80/20 mortgage, the buyer will finalize two distinct loans, and each month needs to make two separate mortgage payments. Does it all sound somewhat convoluted, and maybe even unnecessary? It’s not. Here’s why.
Why use a pair of loans to purchase a house?
Most borrowers look to 80/20 loans to get two benefits: no down payment and the avoidance of having to pay private mortgage insurance (PMI) each month. The tactic does something of an end-run around a more traditional mortgage in which private insurance is required if the homebuyer puts down less than 20% of the cost of the home. Normally, when little or no money is put down on a home, lenders want the security that PMI provides in the event that there’s a default. However, with an 80/20 mortgage loan, the 20% that would normally need to be put down is covered by its own mortgage, so PMI isn’t necessary.
Who qualifies for an 80/20 mortgage?
As 80/20 loans do carry some risk for the lender, borrowers often need to have higher credit scores than they would need for some other types of mortgage loans. Lenders generally want a credit score of at least 700 and like the borrower to have a low debt-to-income (DTI) ratio, 45% or below is usually preferred. Plus, potential borrowers will have better chances of getting approved for an 80/20 mortgage if they have solid employment records, steady residency histories, and a reasonable amount of savings in the bank. While no single one of these factors will be determinative of approval, these are the main things that lenders will probably consider.
What are some of the benefits of an 80/20 mortgage?
Flexibility is a big one. As the second loan for 20% will likely be a home equity line of credit, its use isn’t limited to just paying off the home. After you pay down a portion of that loan, the credit line can then be used for any number of purposes, including the popular choice of cash for home improvements. Then there are tax benefits to consider with an 80/20 mortgage, as interest on mortgage loans — including home equity loans — may be tax deductible.
Do 80/20 loans have any restrictions I should know about?
This varies from case to case and lender to lender. There can be a cap on the amount of the second loan that’s for 20%, perhaps a limit of $100,000. A common requirement set by lenders for 80/20 mortgages is that the borrower lives in the home, using it as their primary residence, so purchasing investment properties isn’t generally possible with the 80/20 route.
What are some costs to consider with 80/20 mortgages?
As you will be closing on two mortgages when you buy your home, you may have to pay the closing costs on each. Though some lenders overlap these costs when issuing 80/20 mortgages. While closing costs on home equity lines of credit (HELOC) are usually lower than those for primary mortgages, they are not insubstantial, usually between 2% and 5% of the loan’s amount. And bear in mind that if the second loan is at a variable rate, that rate has the potential to rise; the historically low interest rates of the recent past were always bound to increase.
VA Loans: Another Way to Buy With No Money Down
An 80/20 mortgage isn’t the only option for putting zero money down on a home. Backed by the U.S. Department of Veterans Affairs, VA loans don’t require a down payment because the government guarantees that the lender will recoup up to 25% of the loan’s amount in the event of default. These loans are available to active-duty members of the military, veterans, and some surviving spouses, all verified as eligible with certificates of eligibility (COEs) they receive from the Department of Veterans Affairs. Beyond the no-money-down aspect, a big benefit of a VA loan is that you don’t have to get mortgage insurance as you do with other types of mortgages when there’s a down payment of less than 20%.
What are some requirements for VA loans? All eligible buyers must live in the homes they’re getting the loans for; VA loans can’t be used to buy investment properties. And there are generally funding fees to consider with VA loans, though some borrowers may be able to get these waived, as is the case with some disabled veterans and recipients of Purple Hearts.
Do you feel it’s time you owned your own home but don’t have quite enough cash for the down payment? If you’re on solid financial ground, an 80/20 mortgage may be the best way to realize your dream of becoming a homeowner. Contact us today to talk about how you may be able to buy a home with no money down.
Your credit score plays a big role in your mortgage eligibility. And understanding this is often the key to getting your dream home. Here’s what a credit score is and why it matters when you’re looking to buy a house.
First, what is good credit? From the perspective of your lender, good credit means a history of using the credit you’ve been given in the past with care and paying back previous loans according to their terms. With these positive credit behavior patterns, you are more likely to get approved for a mortgage at a low interest rate with favorable terms.
Credit Reports and Credit Scores Are Not the Same Thing
A credit score is a number that’s assigned to you as an estimation of your worthiness to get credit. A credit report is a detailed look at your credit history. Let’s drill down a bit on each.
- Your credit report shows how much money you have borrowed, how you’ve paid it back, and how much credit that you have available to you. The report includes debts such as student loans, auto loans, and credit cards, among others. Credit reports also show any red flags, such as referrals to collection agencies, long-overdue bills, bankruptcies, and tax liens. You have a right to receive your credit report; federal law requires each of the nation’s big three credit reporting companies to give you a free copy of yours. You should check out your credit report before applying for a mortgage.
- Your credit score is a number between 300 and 850, determined by a number of factors related to how you’ve managed credit in the past, including the type of credit that’s been extended to you and for how long. The most commonly used credit score is the FICO score, created by a data analytics company previously named the Fair Isaac Corporation, now simply FICO.
Factors That Determine Credit Scores
- Payment history is a big factor in determining a credit score. About one-third of the calculation that sets your credit score relies on how you’ve made payments on your bills. Consistent on-time bill paying gets you good marks, late and partial payments will result in negative marks.
- Balance ratios rank a close second. Known in the finance world as a credit utilization ratio, this split between the debts you owe and the amount of credit you have available is hugely important in determining your credit score. Keeping this number under 30% has a positive impact.
- Credit timelines come in third. Got an old credit account you rarely use? Don’t close it! The longer you’ve had a credit account, the better this longevity contributes to your credit score. Conversely, closing longtime accounts could lower your score.
- Your credit mix is also considered. Lenders like to see diversity with credit, giving credence to the fact that you can handle a variety of credit situations. Open credit, revolving credit, installment credit — it all comes together to paint a good credit picture.
- Recent credit activity plays a part. The flip-side of credit longevity, a flurry of recent credit activity doesn’t bode well for a credit score. While not as significant a factor as payment history or balances owed, applying for multiple credit accounts over a short, recent period can put a dent in your credit score.
What credit score do I need to get a mortgage?
This is often the biggest question people ask before they apply for a mortgage loan and the one that weighs the heaviest in their minds as they await approval. While this varies from lender to lender and other factors may influence the results, a credit score of 620 is generally considered the floor for getting approved for a conventional mortgage. A score of 740 or higher is often considered the range to get the best possible terms and best interest rate on a conventional mortgage.
Can you still get a mortgage if your credit score is in the 500s? Yes. Though if your credit score falls below 620, your best bet is usually to apply for an FHA Loan mortgage, as government-backed loans often have lower credit-score thresholds — with higher down payment requirements based on your credit score. If you have a score of 580 or higher, you may be able to get an FHA loan with only 3.5% down. With a score in the 500 to 579 range, you’re probably looking at a 10% down payment to secure an FHA mortgage.
Specifically designed for veterans and active-duty members of the military, VA Loans are similar to FHA Loans in that they are guaranteed by the government, backed by the Department of Veterans Affairs. The credit-score requirements tend to skew slightly higher for VA Loans over FHA Loans; 600 to 640 is a common range for getting approved for a VA Loan, which often has the advantages of 100% financing with no down payment and no requirement for mortgage insurance.
How can I improve my credit score?
While there is no quick fix, there are steps you can take to improve your credit score. If you have long-standing debts, such as student loans, paying them down will help. All the better if you can close out the debt. But don’t close out paid-up credit cards; best to keep these open as longer-term lines of credit positively affect credit scores. If you can’t completely pay down a credit card, making more than the minimum monthly payments will help.
What if my credit score is still too low to get a mortgage?
Whether it’s due to no credit or bad credit, this is an issue many would-be borrowers face. For many, having a co-signer who does have a good credit score is the answer. Another option is to have another person, a family member or a significant other, buy the home and put your name on the title. When your credit score improves, you can then apply to refinance to have the mortgage in your name.
A good credit score can change your life, handing you the keys to the home you desire. And when you’re ready to embrace that change, lenders at City Lending are ready to serve.