When it comes to home financing, traditional and quite stringent lending rules do not always apply. For instance, homeowners can use nontraditional types of income, like boarder rents, so long as other qualifications, like solid creditworthiness, are met. In addition, 100 percent financing, or no-money-down mortgages, are also an option. One of the ways to achieve 100 percent financing is with an 80-20 mortgage, which is a first mortgage and an equity loan.
These types of mortgages are called "80-20" loans because they refer to the percentage of the total house debt. When you take one of these deals, you agree to a first mortgage comprising 80 percent of the total house debt, and an equity loan comprising 20 percent of the rest of the house debt. For example, if you need to refinance your $300,000 mortgage, you can do an 80-20 refinance, leaving you with a first mortgage of $240,000 and an equity line of $60,000.
Purchase versus Refinance
While most 80-20 loans are used to purchase new homes, you can secure one of these arrangements for a refinance as well. When consumers use the 80-20 loans to purchase homes, they are usually looking to avoid making PMI, or Private Mortgage Insurance, payments on their mortgage. Consumers who cannot afford a 20 percent down payment on a home are usually forced to pay this premium, which protects the mortgage against mortgage default.
In some cases, securing an 80-20 loan during a refinance can be advantageous. For example, if a lender has an internal underwriting criteria mandating certain rates for certain loan amounts, it may be in your favor to choose an 80-20 loan so that your primary first mortgage doesn't exceed the loan amount. In this fashion, you may be able to secure a more competitive rate on your largest home debt -- your first mortgage.
An 80-20 loan has its setbacks, however. Equity loans traditionally have higher interest rates than first mortgages, and the same is true with the 20 percent portion of your 80-20 agreement. Prior to agreeing to this mortgage deal, carefully weigh all the options -- particularly the total interest you'll pay over the life of both loans. Your first mortgage rate may be quite low, but this does not necessarily mean that your equity loan rate will be low as well.
Based in Eugene, Ore., Duncan Jenkins has been writing finance-related articles since 2008. His specialties include personal finance advice, mortgage/equity loans and credit management. Jenkins obtained his bachelor's degree in English from Clark University.