Understanding how 80/20 loans work can be useful to certain borrowers who are looking for home ownership. 80/20 loans allow a borrower to make a loan backed up by a second one in order to cover the cost of the mortgage. This allows the borrower to meet the required 20 percent down payment necessary to avoid having to purchase primary mortgage insurance (PMI). PMI protects the lender’s interest in the event that a homeowner defaults on the loan. When the home’s loan-to-value (LTV) ratio reaches at or below 80 percent, PMI is eliminated.
A secondary or piggyback loan is also taken out to cover the cost of the remaining 20 percent. The borrower will pay a higher interest rate for this loan and in some instances, it may be treated as a home equity line of credit.
The primary mortgage is taken out with a traditional lender. The amount is equal to 80 percent of the mortgage costs. This loan is financed at the prevailing interest rates for home mortgages, based on the credit rating of the borrower. Borrowers with higher credit ratings will receive better mortgage rates for their primary mortgage loan than those with lower credit ratings.