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80-10-10 Mortgage Financing Explained

80/10/10 loans are easy to understand as they have only one purpose. The type of loan and rate of each loan will be determined by availability and interest rates available at the time you are in the market for a loan.

These loans are generally considered creative financing but in truth they are merely combination financing or piggyback loans. They can be used to finance a purchase, refinance, for home improvement, or debt consolidation. Their versatility is an advantage.

Their purpose is to avoid paying Private Mortgage Insurance (PMI). PMI increases the cost of the loan significantly and that is always a disadvantage that should be avoided if possible.

80/10/10 means you finance 80% of the purchase price, put 10% down and take out a second equal to 10% of the purchase price. Because the first loan is at 80%, PMI is avoided. The remaining 20% is covered via the second mortgage and cash down payment.

The borrower enjoys tax advantages because the interest payment on both notes is tax deductible. PMI is an expense that is not tax deductible. Hence, it is an expense that does not need to be incurred.

Another advantage is paying off the second mortgage early thereby reducing your total payment. Remember, it is for a small amount so with a little extra effort, you can pay it off early.

As with almost all financial instruments, there are some potential problems with an 80/10/10 strategy. Some second mortgages carry a prepayment penalty. If a prepayment penalty is included in your second it will be for a certain number of years. For example, you may incur a penalty if you pay it off in three years. Some have a five year penalty phase.

Always ask if the loan has a prepay penalty and, if so, what is its duration. If there is a prepay penalty it may be attached as a rider. While the penalty isn’t a good thing, having a rider explaining it in detail is a good thing.

Another disadvantage with this type of loan is you may actually pay more for it than if you had PMI. You see, the rate on your second may be high because the market for second mortgages is volatile at the time you are applying for a loan.

Also the second mortgage is generally for a shorter period of time than the first mortgage. The first mortgage is usually a 30 year mortgage while the second carries only a 15 or 20 year time frame. Some people feel uncomfortable with two mortgages not having the same payment time frame.

An 80/10/10 also comes dressed as an adjustable rate mortgage (ARM). Adjustable rate mortgages are generally not considered consumer friendly and can cause financial disaster under some circumstances.

Since ARMs are tied to an index, the payments will go in the direction of the index. When the index rises, the payments rise and if the index keeps rising, the payments keep going up.

Although most ARMs are capped at a certain percentage rate, that rate may two or three times the starting rate. For example, your starting rate is 6% but the cap rate (highest it can go) is 12 or 18%. For most people, paying two or three more per month causes a hardship.

An 80/10/10 has its place in the mortgage market and for the most part can be a great mortgage. But, like all mortgages, you must understand the particulars of both the first and second mortgages comprising your mortgage package.

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