A second trust loan is an alternative to private mortgage insurance, also known as a “piggyback loan.” The most common type is an 80/10/10 where a first mortgage is taken out for 80 percent of the home’s value, a down payment of 10 percent is made and another 10 percent is financed in a second trust at a higher interest rate. In some cases, you may even qualify for a second trust loan with as little as a 5 percent down payment.
With today’s home prices, it can be hard to save 20 percent for a down payment. However, if you don’t put down 20 percent, you generally have to pay private mortgage insurance (PMI). A second trust loan can help you avoid PMI.
Typically, 20 percent is expected as a down payment on a house. Otherwise, the lender will require that you pay PMI. PMI is insurance for the lender in case you default on the loan. The theory is that if you are not putting a significant portion of your own money into the home, it is easier for you to walk away from your debt obligation.
The problem is that in many markets, you can make a 5 or 10 percent down payment and still be putting down a sizeable amount of money. For example, if you are buying a $300,000 house, 20 percent is $60,000. Even if you only put down 10 percent, that is still $30,000. Even though, 10 percent down is a significant amount of money in this instance, mortgage companies still require you to pay PMI, which can cost several hundred dollars a month.
Second trust loans allow you to get around paying PMI while still putting down less money.
Here is how it works: You get financing for 80 percent of the purchase price of the home. On that the $300,000 house example used above, that means the mortgage principal is $240,000. The down payment in this scenario is 10 percent, or $30,000. What about the remaining 10 percent? That is where the second trust loan comes in.
The final 10 percent of the purchase price comes from a second trust loan, or a second mortgage. This loan is usually at a slightly higher interest rate than the first mortgage, and it also is for a shorter term. Still, a second trust loan is usually cheaper than paying PMI, and the interest on the loan is likely to be tax deductible. PMI payments are may not be (depending on your financial situation).
Even if you have the full 20 percent to put down on a home, a second trust loan can still be a good idea. You can put down 10 percent, and use the rest of the money to pay off debt or pay for closing costs, moving expenses or furnishings for your new home. If it is a market where homes appreciate quickly, a second trust loan allows you to build equity even though you have a smaller down payment. Your equity just builds with the increase in your home’s value.
If you can’t make a 20 percent down payment on a home, explore your options and see if it pays off for you to use a second trust loan or if you would be better off paying PMI.