Piggyback loans

[PukeNRally]

I'm looking into purchasing my first home and a friend has been telling me about all the benefits of an 80/20 mortgage. He's been trying to convince me that even if you have savings available for a 20% down payment, an 80/20 loan still saves you more money. His reasoning is that while you'll be paying more interest on the 80/20 loan, you'll be more than making up for it by having your 20% down payment invested elsewhere instead of sitting in your house. So, assuming that you will be in the house long enough to build up equity, which would take longer with the 80/20, there's no reason not to select that option.

His logic makes sense, but it seems too simplistic to me. Am I missing something? Can someone explain the benefit to putting 20, 10 or even 5% down as opposed to going the 80/20 route? What are the downsides here?

 

[tropheus]

1. 6% hasn't been the easiest ROI to find these days, even in the stock market (my 401(k) is invested in blue chip stocks and has returned much less than 6% for me this year AND the historical average for ROI in the market is under 10%).

2. Your monthly cost is higher.

3. I've never liked taking chances on housing. Get the best 30 year rate you can find, put 20% down and buy the house that you can afford if bad stuff happens -- kind of a bunker mentality.

That's my perspective. Of course, I am in favor of taking big risks, I just take them in other areas of my financial life.

 

[Bernard]

It all depends on your financial situation and the amount of risk you are willing to take. As stated above, the only benefit comes from earning more on your alternative investment than you are paying in interest for your extra loan.

Where would you invest the extra cash?
What if your investment goes bad?
Do you have enough monthly income to pay the extra debt service and still live comfortably?

I used to have a bunch of money saved up. Thanks to some really poor investment choices, all of that money is gone.

Now I have some more money saved. I have a house under contract and I'm putting 20% down. I plan to have the other 80% paid off in 3 years. The nice thing about a house is that even if it loses value, you can still live it. Once you're out from under the mortgage, no one can take it away from you.

Question: If a bank offered you a $50k unsecured line of credit at 6% interest, would you take the loan and invest in the stock market? Probabaly not, but that's exactly what you are currently considering, but your also pledging you house as collateral.

Why are buying a home and and buying stocks with 100% margin suddenly associated with one another?

Bernard

 

[PukeNRally]

In reply to:

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[tropheus]

I understand what you are saying and I tend to agree but would make two points.

First, by my statement that the monthly cost would be higher, I am speaking to the choices of 20% down or a second mortgage to acheive a primary loan of 80%. PMI is not a consideration in either instance. Of course, if a buyer cannot put 20% down, an 80/10/10 is better for PMI alone.

Second, as for tax breaks, I would never advise someone to take out a loan simply because the interest is deductible -- you pay me $100 and you get a net reduction in tax liability of a max of $35, more likely less than $20 with the graduated tax brackets and other deductions which push AGI well, well below actual gross income earned. Based on that, the choice again falls to 20% down or a second mortgage and invest 10% elsewhere. If the consideration is a tax deduction, consider saving upto $65 by not owing the interest.

Where the tax deduction comes in handy is when you must obtain a loan. Should you do a signature loan, collateralize the loan with some other asset (ex. a car loan) or finance the transaction with a home equity loan? While there are other risks to consider, the tax consideration becomes important.

Again, if the choice is 10% down and PMI or 10% down and a second mortgage for 10%, I'd take the second mortgage assuming I have already decided I could afford the house.