Not long ago, 80/20 mortgages were so commonplace and many home buyers were using them to buy homes with no money down.  Today 80/20 are essentially so nonexistent that is does not matter if you have a perfect 850 FICO score, you still will not be able to find an 80/20 mortgage.  For better or for worse, these loans are no longer being offer to any type of borrower.

If you are wondering “What is an 80/20 mortgage?” let me explain.  An 80/20 mortgage (also called piggyback loans, tandem loans, nothing down mortgage, etc.) is (was) a mortgage for 80% of the purchase price with an additional mortgage for the other 20% of the purchase price, for a borrowed total of 100% of the purchase price.  80/20 mortgages were popular for two reasons:

1. No Down Payment - Financing 100% of the purchase price allowed many buyers with little cash to purchase homes.
2. No PMI (Private Mortgage Insurance) - When your down payment on a home is less than 20% of the purchase price you must pay private mortgage insurance, which insures the lender in case of the borrowing defaulting on the loan.

80/20 Variations - 80/15/5, 80/10/10

There are also other variations of 80/20 loans, such as 80/15/5 and 80/10/10 loans.  With these loans you obtain one mortgage for 80% of the purchase price with an additional mortgage for 10 or 15%, while making a down payment of 5 or 10%, respectively.  The main benefit of these mortgages were not having to pay PMI without making a 20% down payment.

The Abuse of 80/20 Mortgages

80/20 loans have been blamed for contributing to the current housing crisis which in turn has led to the current recession.  There’s really no dispute that many people bought homes (primary residence or invesment) over the last 7 or so years with 100% financing, and now that their home is worth considerably less than what they still owe on it, they have stopped making the payments and abandoned the property.  This has led to many foreclosures and short sales, which is compounding the problem, continuing the fall of home prices.

As I’m currently in the market to purchase a house, I recently came across such a property.  The out of state owners actually bought it and another house in the same neighborhood as investment properties with 80/20 mortgages and nothing down.  In 2006, the owners paid $340,000 for the house I was viewing, and the properties current value is estimated at $215,000.  The owners stopped making payments on this properties last October, so its now listed on the market as a pre-foreclosure, short sale at about 66% of the price it sold for 3 years ago.  I just thought it was kind of amazing that lenders gave this owner 100% financing for two investment properties (that I know of)!

I Hope 80/20s Return

I am not sure whether or not we will ever see 80/20 mortgages return, but I sure hope we do.  Used correctly (with proper underwriting), these mortgages can be very beneficial to the lender, borrower, and the market itself.

Not all 80/20 borrowers are defaulting on their loans.  If lenders had used more discretion when making 80/20 loans would have been able to reduce their risk.   For starters, 80/20 loans should never have been given to purchase investment properties, especially in a housing bubble.  I should also note that most lenders were making loans like this because they knew if they did not make the loan, the next lender would make the loan, and Fannie Mae or Freddie Mac would purchase it, but that’s a separate issue to be dealt with at another time.

A lot of responsible first time home buyers with little cash on hand benefited from 100% financing.  For example, a lot of college graduates enter the workforce and start making substantial incomes, but usually do not have the cash on hand to make a down payment.  In this case, if the graduate’s income was substantial enough to make the payments and the borrower has very good to excellent credit, I see no reason why they should not be given 100% financing.

I consider myself to be in this category, as I graduated from college a few years ago, and I make a good income, but do not yet have $50,000 saved for a down payment on a $250,000 house.  I’m very glad I did not purchase a house a few years ago right out of school, but I’m disappointed 80/20s are no longer available for me now.  There are other options available which I’ve been looking into, such as seller financing, FHA loans (3.5% down), and having sellers pay partial down payment, etc.

Because the many potential first time homebuyers may now have to wait to purchase their first home until they can save enough for a 20% down payment, the pool of potential buyers has been reduced.  This means that the huge inventory of homes one the market will take even longer to sell, and the housing market will now take longer to recover.

After the market recovers, I hope 80/20 mortgages return and are once again available to responsible borrowers.  Although it will be too late for my first home purchase, I think everyone can benefit if they do return.  What are your thoughts?  Do you think they should return, and do you think they will?