When some hear the term “second mortgage,” a negative connotation may come to mind. Some may think it's another form of a risky derivative, but it's not.
The days of homeowners putting down hefty down payments and paying off their mortgage in a number of years are gone. Now days potential homeowners are considering second mortgages as a form of down payment. These are most often referred to as "piggyback loans" because it sits behind the first mortgage. Typically the first and second mortgage are both closed at the same time during a home purchase.
The two most common types of second mortgages or piggy back loans you will see are:
- 80/20 - This loan finances 80% of the first mortgage and 20% of the second mortgage, requiring no down payment.
- 80/10/10 - This loan finances 80% of the first mortgage, 10% of the second mortgage, and requires a 10% down payment.
You will find monthly payments on second mortgages are typically pretty low relative to the first mortgage, this is because the loan amount is generally much lower. However, interest rates on second mortgages are generally higher than the first mortgage, so be sure to do the math and make sure it's right for your situation.
The primary advantages of utilizing a second mortgage are simple:
- Requires less down payment
- Typically used to avoid private mortgage insurance (PMI)
If you are unfamiliar with PMI, in short it is an insurance policy for FHA loans that compensates lenders when/if borrowers default on their loan. The amount of PMI you will pay is dependent on your credit score and the value of the home. Additionally, PMI is not tax deductible while the interest from the 2nd mortgage is tax deductible.
How to Use TSP Loan as a 2nd mortgage
The typical home mortgage has a loan term of either 15 years or 30 years. As previously discussed you can use a second mortgage as a form of borrowing for a down payment. But you can use a TSP Loan to function as a second mortgage in order to significantly pay down the principal of your first mortgage which will lead to a shorter loan term.
Using a TSP Loan as a second mortgage, you withdraw a specific amount then pay it towards your principal mortgage. This will not eliminate or lessen the payment of your first mortgage, however it will reduce the amount of interest you will pay overall and shorten your loan term due to early payoff.
This sounds like a smart and financial savvy idea but you have to remember a few things:
Mortgage Rates Are Historically Low - The rates are between 3-4% right now, and while interest rates on TSP Loans are lower at the moment, generally speaking the amount of interest and time saved will not be worth the hassle. Especially once you factor in the interest and time saved from simply making additional payments every month.
This doesn't mean you should completely rule out a TSP Loan as a second mortgage but you have to do the math to ensure it is right for your situation.
The Math Behind Second Mortgage
You have found your proverbial "forever home" and want to take advantage of low interest rates now. For some reason or another you simply do not have enough savings to come up with a large enough down payment to avoid PMI. Therefore you have chosen to use a TSP Loan as a second mortgage.
TSP Portfolio Balance: $34,000
80/10/10 Mortgage Financing: $225,000 home price
- First Mortgage = $180,000
- Second Mortgage = $22,500
- Down Payment = $22,500
Second Mortgage Financing Options:
- TSP Loan: $22,500 | 1.875% - 10 years
- Conventional Loan: $22,500 | 5.15% - 10 years
John can take out a Residential TSP Loan for $22,500 ($275 x 12 months) at a lower rate than his current mortgage and pay that towards his principal all in one month or he can simply make extra payments of $275 on a monthly basis towards his mortgage.
TSP Loan vs. Conventional Loan
Monthly Payment: $206 vs. $240
- Total Monthly Payments = $24,720 vs. $28,800
Interest & Fees: $2,270 vs. $6,336
Opportunity Loss In The Stock Market: $18,554 vs. $0
On the surface, using a TSP Loan as a second mortgage seems like the right decision. Based on the initial calculations you are saving approximately $4,000 in interest over the life of the 10 year loan. However, once you factor in the opportunity loss that money would have potentially generated it doesn't make financial sense. Not in the least bit.
As always, it is imperative to look at every situation in its entirety while applying sound financial principles. Perhaps there is a situation where it would make sense to use a TSP Loan as a second mortgage, but we haven't found it.
Here's to our wealth!