How can I avoid taking out a piggyback loan?

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Q. How can I avoid taking out a piggyback loan? Right now, I'm looking at financing with an 80-10-10 loan. But I've read that you can buy private mortgage insurance instead.

A. That's right. When you take out a loan for more than 80% of your home's value, you must purchase private mortgage insurance (PMI), which protects the lender should you default.

One way around that is to take out a primary loan for 80% and a second mortgage to cover the remaining 20% -- or however much you need to make up the difference between 20% of the purchase price and your down payment.

Real estate agents really pushed this type of piggyback financing in the early 2000s when you could get a home equity loan at rates under 5%. Often, those rates were less than the rates on the primary loan and the payments for both loans were often less than if you borrowed the entire amount with a single loan and paid the premiums for PMI.

But that's no longer the case. Home equity loans now cost more than a primary mortgage -- typically 7% to 8% -- so your monthly payments will be less if you go with a single loan and PMI. (Our extensive database of the best mortgage rates is a good place to start shopping.)

Piggyback loans are also very difficult to get today because so many borrowers who used that kind of financing are defaulting. Indeed, such loans are virtually impossible to obtain in what banks consider "distressed markets" with high foreclosure rates and rapidly falling prices. Virtually all of California and much of Nevada, Florida and Arizona fall into that category.

So, if you put 10% down and get a single loan to finance the rest of your purchase, you'll need to carry PMI. You won't have to find an insurer. Your lender gets to pick one and the monthly premium will be included in your mortgage payment.

These policies cost about 0.5% of the outstanding principal per year. That's something like $90 a month for a median-priced home ($218,900 in 2007). The exact cost will depend on the size of your down payment, the type of mortgage you get (adjustable-rate loans cost more than fixed-rate loans) and the term of your mortgage. Premiums on a 30-year mortgage will cost more than those on a 15-year. Your lender will be able to tell you exactly what the payments will be.

Once you've built 20% equity in your home, you can ask your lender to cancel the insurance. (Your equity is the difference between what your home is worth and how much you owe.) That usually requires you to pay for an appraisal, because you can include price appreciation as well as paid equity to achieve your 20% share. You also must have a good record of on-time mortgage payments.

The lender will cancel PMI automatically when you reach 22% equity, but that is based solely on paid equity and most homeowners can achieve their 20% sooner by figuring in price appreciation.

During the first few years, if you can add a little extra to your mortgage payment, that also will speed up your quest to build 20% equity, saving you money in the long run.

There are two other benefits to going with PMI.

The premiums are a fully tax-deductible expense, just like the interest on your mortgage, for loans taken out this year.

You'll also have one less worry if you want to refinance your home. Because of the mortgage crisis, many home equity lenders are not allowing homeowners to refinance their primary loans without first paying off their second mortgages. That's particularly true in distressed markets.

Whether you're buying a home or refinancing an existing mortgage, we have a mortgage calculator that can help you make the right decisions.

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