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80/20 loans are not as complicated as people may think. Many lenders will only finance 80% of the home purchase price, which leaves 20% for the borrowers to come up with. While having a down payment is ideal, some borrowers do not have enough of a down payment to cover 20%, and some may not have a down payment at all. In this scenario, a second loan for 20% of the home value can be taken out, as a home equity or piggyback loan. This is the best way to get 100% financing because neither the 80 or the 20 loan will require a down payment, since they are both incomplete loans.
How They Work
The first loan is for 80% of the purchase price. The second loan, for 20% of the purchase price, works as a revolving line of credit for 15 years and then must be paid in full over the course of the last 10 years of the loan term. The first loan prevents the borrowers from having to take out a private mortgage insurance (PMI) policy, which helps them save money. PMI is usually required when any mortgage covers more than 80% of the home value, because it is a risk for the bank. The insurance works to protect the bank, but since the cost is passed on to the borrower, it makes it harder for the borrower to handle.
When a borrower cannot come up with 20% down, an 80/20 loan is usually the best route to go, because it is less expensive than having to carry PMI. The 20% loan will generally carry a higher interest rate than the first trust deed loan, so it is important to carefully manage finances.
Qualifying for an 80/20 Loan
Generally, only those with a good credit standing, a score of at least 700, can qualify for 80/20 loans. Because there is no down payment involved, 100% financing is a very large risk for most lenders, so they will only trust borrowers who have shown they have the ability to pay their debts. In addition to a good credit history, applicants should have a stable employment history, a decent amount of money in savings, a stable history of residency, and a low debt-to-income ratio (DTI). The debt-to-income ratio should be 45% or less if possible. The better the employment, residency and DTI are, the lower the interest rates on the loans will be.
Due to the recent housing industry crisis, these loans are only extended to the most worthy borrowers, and are not offered by all lenders. If you are interested in getting 100% financing through an 80/20 loan, look at your credit report before you begin talking to various lenders to find a program that works for you. Depending on the situation, you may be better off waiting for a few more months to improve your credit and pay down some debt.
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