
In the realm of real estate financing, piggyback loans offer a unique strategy for buyers looking to avoid or reduce private mortgage insurance (PMI) premiums while potentially maximizing their purchasing power.
These loans involve taking out two mortgages simultaneously, one for the majority of the purchase price and a second smaller loan to cover a portion of the down payment. While piggyback loans have their advantages, it's crucial to understand their complexities and potential risks before deciding if they're the right fit for your home-buying journey.
What is a Piggyback Loan?
A piggyback loan, also known as a piggyback mortgage or an 80-10-10 loan, is a financing strategy where a homebuyer takes out two loans concurrently to purchase a property. The first mortgage typically covers 80% of the home's purchase price, while a second loan, often a home equity loan or line of credit (HELOC), covers the remaining 10%. The buyer then contributes a 10% down payment.
How Do Piggyback Loans Work?
Two Mortgages, One Home: Instead of obtaining a single mortgage for the entire purchase price, a piggyback loan involves taking out two separate mortgages simultaneously.
First Mortgage: This is the primary mortgage and typically covers 80% of the home's purchase price. It often has a lower interest rate and stricter qualification requirements, similar to a conventional mortgage.
Second Mortgage (The Piggyback): This is a smaller loan that essentially "piggybacks" on the first mortgage. It covers a portion of the down payment, usually 10%. The second mortgage can be a home equity loan, a home equity line of credit (HELOC), or even a personal loan. It typically has a higher interest rate than the first mortgage due to its riskier nature.
Your Down Payment: To complete the purchase, you'll still need to contribute a down payment from your own funds. In the classic 80-10-10 piggyback model, this down payment is typically 10%.
Why Use a Piggyback Loan?
The primary allure of a piggyback loan lies in its potential to save you a substantial amount of money by avoiding private mortgage insurance (PMI). PMI is an additional insurance premium that lenders require when your down payment is less than 20% of the home's value. It's designed to protect the lender if you default on your mortgage.
Learn more:
Loan-to-Value (LTV) Ratio: The Secret to Smarter Real Estate Deals
The Cost of PMI:
PMI premiums can add a significant amount to your monthly mortgage payment. The exact amount you pay depends on factors like your loan amount, credit score, and the type of loan you have. However, it can typically range from 0.5% to 1% of your loan amount per year.
Example:
If you purchase a $300,000 home with a 10% down payment ($30,000), your loan amount would be $270,000. If your PMI rate is 0.75%, you'd pay an additional $2,025 per year in PMI premiums, or roughly $169 per month.
Eliminating PMI with a Piggyback Loan:
A piggyback loan allows you to circumvent PMI by essentially "boosting" your down payment. For instance, in the example above, you could take out a second mortgage (piggyback loan) for $30,000, bringing your total down payment to 20%. This would eliminate the need for PMI, saving you $2,025 per year in the above scenario.
Beyond Avoiding PMI:
While avoiding PMI is the main reason for using a piggyback loan, it's not the only benefit. It can also:
Increase your purchasing power:
By avoiding PMI, you'll have more money available each month for your mortgage payment. This can allow you to qualify for a larger loan amount and potentially purchase a more expensive home.
Take advantage of low interest rates:
In some cases, the combined interest rates of the first and second mortgages may be lower than a single mortgage with PMI. However, it's crucial to compare rates and terms carefully.
Who Should Consider a Piggyback Loan?
Who Should Consider a Piggyback Loan? A Closer Look at Potential Candidates
Piggyback loans can be a strategic tool for certain homebuyers, but they're not a one-size-fits-all solution. Let's delve deeper into who might benefit from this financing option:
Buyers with Limited Savings:
Saving for a 20% down payment can take years, especially in expensive housing markets. Piggyback loans provide an alternative for those who have saved at least 10% but not the full 20%. By securing a second mortgage for the remaining 10%, buyers can avoid PMI and get into their desired home sooner.
Buyers with Good Credit:
Piggyback loans involve obtaining two separate mortgages, so lenders typically require a good credit history and score for both loans. This ensures that the borrower is considered a low-risk borrower and capable of managing multiple monthly payments.
Buyers Seeking to Maximize Borrowing Power:
While piggyback loans involve two mortgages, the combined monthly payments may still be lower than a single mortgage with PMI. This can increase your overall affordability and allow you to qualify for a larger loan amount.
By avoiding PMI and potentially qualifying for a larger loan, you may be able to afford a more expensive home than you could with a traditional mortgage.
Pros and Cons of Piggyback Loans
Pros
Significant Savings:
PMI typically costs between 0.5% and 1% of your loan amount annually. Over the life of a loan, this can add up to thousands of dollars. A piggyback loan allows you to avoid PMI altogether, saving you a substantial amount over time.
Improved Cash Flow:
By eliminating PMI, you free up more of your monthly budget for other expenses or savings goals. This can be particularly beneficial for first-time homebuyers or those with tight budgets.
Larger Loan Amount:
Without the added expense of PMI, you may qualify for a larger loan amount. This can open up opportunities to purchase a more expensive home or a property in a more desirable location.
Competitive Advantage:
In a seller's market, where multiple offers are common, the ability to offer a larger down payment (thanks to the piggyback loan) can make your offer more attractive.
Tax-Deductible Interest:
In some cases, the interest paid on both the first and second mortgages may be tax-deductible, providing additional savings. However, it's crucial to consult with a tax professional to understand the specific rules and limitations.
Cons
Second Mortgage Costs:
The second mortgage (piggyback loan) typically carries a higher interest rate than the first mortgage due to its smaller size and potentially higher risk for the lender. This can increase your overall borrowing costs.
Variable Rates:
Some piggyback loans have variable interest rates, which means your payments can fluctuate over time, making budgeting more challenging.
Two Loans, Two Payments:
With a piggyback loan, you'll have two separate mortgage payments to manage each month. This can be a significant financial burden, especially if you're already stretching your budget to afford the home.
Potential for Default:
Having two loans means you have double the risk of defaulting on your payments. If you fall behind, you could face foreclosure on both mortgages, jeopardizing your homeownership.
Difficulty Refinancing:
If you decide to refinance later, having two loans can complicate the process and limit your options.
Lower Home Equity:
Because your loan amount is higher, it will take longer to build equity in your home.
The Bottom Line
Piggyback loans can be a useful strategy for certain homebuyers, allowing them to avoid PMI and potentially increase their purchasing power. However, it's essential to weigh the pros and cons carefully and understand the risks involved. If you're considering a piggyback loan, consult with a mortgage professional to explore your options and determine if it's the right path for you.