80/20 Loans Explained

Almost half of all first-time homebuyers finance the entire cost of their home, instead of paying a hefty down payment. And many of these zero-down mortgage buyers did so thanks to the so-called 80/20 mortgage plan. This is a type of loan that was particularly designed to assist buyers who would like to avoid paying down payments. When housing prices skyrocket, more and more buyers with good credit and strong income find that they cannot afford a home due to the trouble of saving up enough money to make the big down payment. On a home that costs $300,000, a 20 percent down payment is a whopping $60,000. To help with this challenge, mortgage companies started to offer the 80/20 loan option.

The 80 20 loan is sometimes referred as a piggyback loan, for the reason that it is actually two loans working in tandem as one. The first part works in a conventional way, and is for 80% of the purchase price. The second part - the smaller one - is a 20% loan. So when you apply for an 80 20 mortgage, the lender in reality qualifies you for 100 percent of the purchase price of your home, and then divides the loan into two sections. 

For instance, if you want to buy a house worth $200,000, the down payment of 20 percent will cost $40,000. With an 80/20 loan, the lender will offer you $160,000 at one interest rate, and then give you the 20 percent down payment of $40,000 at a higher rate, for a grand total loan amount of $200,000. 

The reason for dividing up the mortgage into two distinct parts is to help you qualify for a loan without a down payment. Normally you have to put 20 percent down to get a conventional 80 percent loan, so with this quite clever mortgage plan, the lender is letting you borrow your down payment. Then the same lender could turn around and let you borrow the rest of the loan.  

Yes, it does sound a bit contrived, and it is certainly a rather difficult way to arrive at a basic mortgage. But what really counts for those trying to avoid a big down payment is that it works, and helps in overcoming the down payment hurdle. 

You could expect to pay higher rates on the down payment or 20 percent portion of the loan. But the rates are still reasonable, and this loan arrangement will allow you to buy a home without first saving huge amounts of money to use for your down payment. Later, if you decide to pay in full the 20 percent loan in order to lower your monthly payments that is an alternative available to you. A lot of homeowners refinance when they have had a couple years to increase their equity, and change their 80/20 into a more traditional type of mortgage.