What Is A Piggyback Loan?
When purchasing a new home, you may need or want a “piggyback loan” which is literally a loan that "piggybacks" off another loan. Basically, it’s two loans that are opened simultaneously. The first loan is generally 80 percent of the purchase price of the home. The second is typically a home equity line of credit (HELOC) on top of the first mortgage.
Piggyback Mortgage History
Before the housing crisis of the early 2000s, home buyers lacking the traditional 20% down payment were getting piggyback loans. According to New York University’s Furman Center for Real Estate and Urban Policy, it was a popular choice. For example, in 2006, 25% of all home buyers used a piggyback loan.
In other words, home buyers used two loans to cover the cost of the home: one for 80% of the cost of the home, and 20% for the down payment. However, once the housing bubble burst, many homeowners found themselves in financial trouble. They were upside down or underwater on their home loans: they had negative equity in their homes. This led to many people defaulting on their home loans.
As a result, since the housing recovery, we now see piggyback loans being limited to 90% loan-to-value. That means home buyers can still get piggyback loans — with some caveats like a 10% down payment.
Today we see piggyback loans as 80/10/10 where a first mortgage is taken out for 80 percent of the home’s value, a down payment of 10 percent is made, and another 10 percent is financed at a higher interest rate in a second trust loan. It’s possible, although less likely, for home buyers to qualify for a piggyback mortgage with as little as only 5 percent down (known as an 80/15/5).
Why Get a Piggyback Loan?
When you purchase a home, you can get a piggyback loan as an alternative to private mortgage insurance (PMI). Piggyback loans eliminate the need for PMI. You combine this loan with your down payment to reach the 20 percent down needed for a conventional mortgage. This can significantly lower the interest rate of your mortgage.
Many lenders will finance loans with down payments of less than 20 percent, but you’ll pay a price. Usually, the lender insists you buy PMI — this guarantees the outstanding balance of your loan will be paid off if you default. You will either pay a lump sum each year for PMI or add the cost to your monthly mortgage payments.
Private mortgage insurance, or PMI, is one expense that most homeowners would rather live without. While you can ask your lender to cancel PMI once you’ve accumulated 20% equity in your home, that could take a while. So, to sidestep PMI, many borrowers have decided on a piggyback mortgage—effectively taking out two mortgages at once in order to avoid mortgage insurance altogether.
How Does a Piggyback Loan Work?
A piggyback loan is sometimes called a “piggyback mortgage,” “second trust loan,” or “combo loan,” which is a type of mortgage that is designed to help you get a more affordable mortgage payment.
Typical piggyback loan packages are:
80-20 (80 percent first mortgage, 20 percent second mortgage, and no down payment from the buyer)
80% of the loan for the purchase of the property is taken out first. Then the 20% that is left is taken out as another loan in the form of a HELOC or home equity loan. As we mentioned earlier in this article, this is less common today than it was a decade ago.
80-15-5 (a 15 percent second mortgage, and a five percent down payment)
80% of the loan for the purchase of the property and then 15% is taken out as a HELOC or home equity loan. The remaining 5% is put down by the buyer.
80-10-10 (80 percent first mortgage, 10 percent second mortgage, and 10 percent down payment from the buyer)
80% of the loan for the purchase of the property and then 10% is taken out as a HELOC or home equity loan. The remaining 10% is put down by the buyer. Obviously, this depends on what is best for the buyer and how much money they can actually put down. An 80-10-10 loan is much more cost effective for people with great credit scores. For those with a less-than-stellar credit score, the secondary mortgage is often a HELOC. These can have a particularly high interest rate—and they are variable, which means they may get even higher over the life of the loan.
Buyers considering this financing should compare the costs of a second mortgage (they do have higher interest rates than first mortgages) with the cost of a bigger first mortgage plus mortgage insurance. They should compare the after-tax costs, because borrowers with higher incomes may not be able to deduct mortgage insurance, but they may still be able to write off mortgage interest.
If you get a piggyback loan, you will close on it the same time as you close on the mortgage. You will most likely have to pay closing costs, which will require additional upfront cash. You will probably also have to make two loan payments each month — one for your mortgage and one for the piggyback loan. The interest rate on the piggyback loan will probably be higher. But, the monthly payments of both loans are often still less than they would be if you were paying PMI.
Benefits of a Piggyback Loan
Sometimes home buyers decide on a piggyback mortgage to avoid PMI, which is usually between 0.3 and 1.5% of the loan value. Because the amount you have to pay for PMI is based on the size of your loan, a piggyback loan may make better financial sense. Additionally, PMI rules don’t apply for a piggyback mortgage, so it won’t factor into your monthly mortgage calculations.
While avoiding PMI is the primary reason that most people look into getting a piggyback loan, it isn’t the only reason. Since they technically are composed of two mortgages, a piggyback mortgage can help you bypass lending limits for jumbo mortgages, allowing you to buy a more expensive home.
Piggyback loans make the most sense for home buyers who are planning to borrow a substantial amount, such as a jumbo loan. A jumbo loan is a mortgage that is higher than Freddie Mac and Fannie Mae loan limits. Jumbo borrowers often choose two mortgages since they can get a better interest rate on the first loan while giving them the option to quickly pay off the second loan to save on interest payments.
Reasons why getting a piggyback loan could be beneficial for you:
It allows you to buy a home with less money down, decreasing spending.
You can avoid paying private mortgage insurance or PMI as part of your monthly payments
These loans can be used to avoid getting a jumbo loan, which can end up costing a lot of money.
Any interest paid on the piggyback loan is tax deductible.
Drawbacks of a Piggyback Loan
Conversely, piggyback loans are not well suited for everyone.
Here are a few reasons why getting a piggyback loan could be detrimental for you:
The cost of the second loan could be much higher than the first mortgage when you take the interest rate into account. You should know that lenders are taking a bigger risk on the second mortgage and often reflect that in the cost.
You’ll have two mortgage payments per month that could total more than the costs added by PMI. The second mortgage loan will probably have a higher interest rate than the first one. Sometimes that can add up to paying more for a piggyback loan than you would have by going the traditional mortgage route. The second loan doesn’t go away until you pay it off, unlike PMI, which you can cancel once your loan value becomes less than 80% of your home’s value.
Taking out a second mortgage will require you to pay closing costs. While a piggyback loan can be great if you don’t have enough down payment available, you’ll be taking out two loans. That means closing costs on both of them — so you’ll pay double for any fees the lender charges.
It’s possible that taking out a piggyback mortgage now can come back to bite you later if you try to refinance the mortgage at some point in the future. It may be much more difficult to refinance than a single mortgage since you’ll often need the approval of both your primary and secondary lender to do so. Plus, if your second mortgage is a HELOC (which it often will be), the interest rates are usually variable. That means they could go up during the duration of your loan.
Alternatives to Piggyback Loans
If you look, you can often find alternatives to piggyback loans with the same great benefits. They include home ownership investment and FHA loan.
Home Ownership Investment
One common alternative is using a homeownership investment from the company of your choice. A homeownership investment is when buyers raise funds from a private company that will give them cash in exchange for equity in their home.
Typically, homeowners will get 10% of the value of the home in exchange for a specific amount of equity. This is usually around 35 – 50%, in addition to getting their money back. A homeownership investment helps you increase your purchasing power and/or get a lower monthly payment without taking on more debt.
For an alternative to a piggyback loan, see if you qualify for an FHA loan. These are government-backed loans that allow down payments as low as 3.5%. Although you’ll have to pay a type of mortgage insurance with an FHA loan, it might be more affordable than taking out two home loans.
Despite the fact that FHA loans don’t require PMI, they do require paying a mortgage insurance premium, or MIP, which is usually required for the entire life of the loan. In addition, borrowers are often required to pay a one-time upfront MIP payment of 1.75% of the loan.
Borrowers looking to save money find that an FHA loan is a popular alternative to a piggyback mortgage. However, despite the fact that they do require a larger down payment, an 80-10-10 loan can end up being significantly less expensive than an FHA loan.
What is the Interest Rate on a Piggyback Loan Like?
Since the piggyback loan is a home equity loan (HEL) or line of credit (HELOC), the rates for these kinds of loans are usually based off the prime rate plus a margin, while 30-year fixed-rate mortgages tend to follow the 10-year treasury rates. If interest rates rise (as they’re expected to do) HELOC rates might rise above those for a fixed-rate first-lien mortgage. Interest rates vary by lender, too.
By calculating the blended rate, which is a weighted average of the interest rates for the two mortgages, you’ll be better able to understand the total cost. HELOC rates do change over time, however, since they’re pegged to the prime rate. In other words, a borrower’s rate is determined by various factors such as credit score, income and assets, loan balance, and LTV ratio.