Loan 80-10-10: What is it?

Definition of 80-10-10 Loan

The 80-10-10 loan is a mortgage financing structure where 80% of the home purchase price is paid through a primary mortgage, an additional 10% as a secondary loan, and another 10% as a down payment.

How the 80-10-10 Loan Works

Home buyers must make a down payment of at least 20% and obtain a mortgage that does not exceed 80% of the home’s purchase price. If you obtain a conventional loan and do not make a down payment of that percentage, you will typically need to pay private mortgage insurance (PMI). For example, if you make a down payment of only 10%, you would need to obtain a loan with private mortgage insurance for 90% of the home’s purchase price.

The 80-10-10 loan allows borrowers who cannot afford a 20% down payment to avoid paying mortgage insurance, as the secondary loan covers the initial 10% down payment. It also enables home buyers to acquire a high-value property without needing a massive loan. With the 80-10-10 loan, the borrower receives financing for 90% of the home’s purchase price, but does so by obtaining two loans simultaneously. The first loan is the primary mortgage for 80% of the home’s purchase price, issued at a standard interest rate. The second loan is for 10% of the purchase price, usually in the form of a home equity loan or a home equity line of credit (HELOC) at a variable interest rate (and usually higher). The borrower makes a 10% down payment on the remaining purchase price.

For example, let’s assume you are buying a home for $300,000. Under the 80-10-10 loan, you might take a primary loan for $240,000, a home equity loan for $30,000, and make a down payment of $30,000.

Advantages and Disadvantages of 80-10-10 Loans

These loans have both advantages and disadvantages:

Advantages:

• Avoid paying mortgage insurance: The main advantage of obtaining a secondary loan is that it saves you from paying the costly mortgage insurance typically imposed on conventional mortgages when you do not make at least a 20% down payment on the purchase price of the home. Your private mortgage insurance is added to your total monthly loan payment to the lender. This can force you to cut back on your other important monthly expense budgets.
• Avoid the need for a large loan: If you have a desire to buy a high-value home but have either unavailable high income (such as a new job, for example) or high-value but illiquid assets, the secondary loan in the 80-10-10 loan arrangement can enhance your borrowing power so that you do not need to take out a large loan. This is a loan that allows borrowers to exceed federal loan limits, but it can be difficult to find and may require a high down payment.

Disadvantages:

• Variable interest rates on the secondary loan: The interest rate on the first mortgage can be fixed or variable. The interest rate on the second mortgage or home equity loan is typically higher and usually variable, changing with the level of interest rates in the economy. A variable interest rate can be a drawback during periods of high interest rates or inflation. If your rate rises, your loan costs will increase.
• Difficulty in refinancing: The 80-10-10 loan is difficult to refinance because it requires both the first and second mortgage lenders (if they are different) to agree to the refinancing. You may find it even harder to persuade both lenders to refinance if your home’s value has decreased.

Requirements

80-10-10 Loan

During the real estate market boom of the 2000s, this type of loan became widely available with lax requirements. There was little need for down payments, meaning that homes could be almost fully financed. However, those lax measures also led to increased rates of defaults on mortgages when market conditions worsened. Since then, banks and other lenders have tightened their lending standards and applicants have been scrutinized more closely.

Here are some requirements to consider when applying for an 80-10-10 loan:

• Credit Score: Your credit score will determine the interest rate and terms you will receive on the first and second loans. Lenders typically require a minimum credit score of 620 for those seeking a second mortgage, which is the same minimum score you will need for a conventional mortgage. However, second mortgage holders have historically been more creditworthy than those with a single mortgage. This is partly due to the higher risk for the lender with a second mortgage; a decrease in home value could mean that the collateral would not be sufficient to cover the second mortgage after paying off the first.
• Financial Documentation: The borrower must be ready to provide the lender with information such as income and the market value of the home. You may have to provide two sets of documentation if the first mortgage and the second mortgage or home equity loan are provided by different lenders. The two lenders may also require different types of documentation.
• Debt-to-Income Ratio: Like the first mortgage, your debt-to-income ratio (your monthly debts divided by your total monthly income) should not exceed 43% to secure a second mortgage.

80-10-10 Loan vs Private Mortgage Insurance (PMI)

Lenders may recommend a second loan as an alternative to paying for private mortgage insurance (PMI), but they are not the same offer.

Specifically, the 80-10-10 loan is a loan structure that homebuyers can use to avoid paying for private mortgage insurance (PMI). In contrast, private mortgage insurance (PMI) is a type of mortgage insurance that you may need with a conventional loan if you make a down payment of less than 20% of the home’s purchase price, and the lender handles mortgage insurance through a private company. The insurance provides lenders with the assurance that if the home goes into foreclosure, the lender will not incur a loss.

Private mortgage insurance (PMI) is an additional fee that is typically added to the borrower’s monthly mortgage payment. It usually amounts to a small percentage of the principal mortgage amount – from 0.25% to 3% – which may be manageable for a small mortgage but could be burdensome with a large mortgage. This makes the 80-10-10 loan particularly attractive for borrowers seeking high-value mortgages but who cannot cover a typical down payment.

However, the interest rate on the second loan in an 80-10-10 loan may be higher or lower than private mortgage insurance (PMI) with a conventional loan, depending on factors such as how long you plan to stay in the home. This means that the 80-10-10 loan could be more or less expensive than the conventional loan with mortgage insurance in some cases. Borrowers should conduct a cost analysis of the total loans in each scenario to determine which is more affordable.

Summary

The 80-10-10 loan refers to a mortgage financing structure that includes a first mortgage, a second mortgage, and a down payment of 80%, 10%, and 10% respectively of the purchase price of the home. This structure benefits borrowers who cannot make a typical down payment but want to avoid private mortgage insurance (PMI), or those looking for a high-value mortgage and want to avoid a large loan. However, high secondary interest costs and difficulties in refinancing mean that the loan is not always a better option than a conventional loan with private mortgage insurance (PMI). Buyers should conduct a cost analysis of both options to determine which is most suitable for their needs.

Source:
https://www.thebalancemoney.com/what-is-an-80-10-10-loan-4584734