Piggyback mortgages are taken out to avoid having to pay for private mortgage insurance, or PMI when they want to put down less than 20% of the purchasing price. PMI is an insurance policy that lenders require buyers to take out as a collateral when they want to save on upfront costs. With PMI, if a buyer defaults on a loan, the lender will regain the money lost.
The amount a buyer has to put down for PMI varies based on loan amount and the amount the equity. A piggyback loan makes the most sense for those taking out substantial amounts. A benefit of a piggyback loan is that the interest is tax deductible up to the first $100,000.
Piggyback Loan Factors
A piggyback loan is a second loan opened simultaneously along with the first to cover a higher percentage of the home’s purchase price. They often result in lower monthly payments but may not be for everyone. There are some factors that should be considered when choosing a type of loan.
– A high credit score will drastically increase your ability to take out a piggyback loan. Generally, at least a score of 680 is necessary.
– Refinancing may be affected in the future unless the second mortgage is paid off or subordinated. You must get your lenders agreement to make their loan second in importance in respect to a new mortgage, and this can be difficult.
– A second mortgage will often have a variable rate. If the prime rate was to increase, so would the piggyback rate and payment.
– Second loans typically have higher interest rates than first mortgage due to higher risk. While PMI can be canceled once your loan value goes down below 80%, a second mortgage is permanent until paid off.
– A piggyback loan is also referred to as a home equity line of credit. Piggyback loans often only require interest to be paid on a monthly basis, which means that the balance may remain the same even after years of making payments.
– The two loans will need separate documentation if they are placed with two separate banks. This means that although you may be saving money in the short term, in the long term there are double the administrative fees, origination costs, closing costs, etc.
Buying a home without a 20% down payment is also possible with other options. Many states offer down payment programs or grants for first-time homebuyers to help with purchasing homes. There are also government backed loans, or FHA loans, that may allow 3.5% down payments.
History of Piggyback Loans
Before the housing crisis, many lenders would offer home loans regardless of the ability to put down the historically required 20% down. Nearly 20% of borrowers used piggyback loans at the height of the real estate boom, in 2006, according to a study done at NYU. Originally, the loan amounts were 80% – 20%, which meant that the two loans would cover the full amount. When the housing bubble finally popped, things began to change. Homeowners suddenly found themselves with negative equity, also known as ‘being underwater’. This meant that they would most likely default on their loans, and two mortgages meant a more difficult time refinancing. Now lenders require borrowers to put down a 10% down payment.