Definition, types, advantages and disadvantages, alternatives
- With a piggyback loan, you take out one larger mortgage and a smaller second.
- The funds from the second mortgage go towards your down payment, which can mean better terms on the first mortgage.
- A piggyback loan comes with additional costs, so be sure to consider whether it would actually save you money.
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When you want to buy a home, having a down payment can be a big hurdle, especially if you want to put down 20% to avoid paying private mortgage insurance. If you’re struggling to pay a large down payment, a piggyback loan might be a good option for you.
What is an additional loan?
A piggyback loan involves taking out two mortgages, one large and one small. The smaller mortgage “grafts” onto the larger one. The principal loan is a conventional mortgage. The other is a home equity loan or a home equity line of credit.
The main reason for taking out a piggyback loan is to avoid paying for private mortgage insurance.
“Sometimes they work really well,” says Darrin Q. English, senior community development lending manager at Quontic Bank. “Even if you have rates that are in the nines or tens on that second mortgage, that still represents a lower monthly payment and better use of your income, compared to paying insurance premiums that do nothing to you.”
Types of piggyback loans
There are many different types of layered loans, and their main differences come down to math.
An 80-10-10 loan is probably the most common type of piggyback loan. The first mortgage is 80% of the purchase price, the second is 10% and you provide 10% cash for the down payment. By combining the second mortgage and the money you have already saved for the down payment, you will have 20% in total to pay.
This is similar to an 80-10-10 loan, but you may prefer it if you have around 5% for a down payment rather than 10%.
An 80/20 loan is a valid option if you have little or no money saved for a down payment. Your first mortgage is 80% of the price of the house and the second mortgage is the 20% you will use for the down payment.
A 75-15-10 loan is most often used for condominiums because interest rates on condos are higher when borrowing more than 75% of the purchase price.
Advantages and disadvantages of a piggyback loan
- You avoid private mortgage insurance. With conventional mortgages, you have to pay PMI if you have less than 20% for a down payment. By using a second mortgage to achieve a 20% down payment, you don’t have to pay up to hundreds of dollars every month for PMI.
- You can avoid a jumbo mortgage. You must apply for a jumbo mortgage if you want to borrow more than the FHFA allows. Jumbo mortgages have more stringent requirements that you may or may not meet, and they charge higher interest rates. Taking out a second mortgage will reduce the size of your first mortgage, saving you from applying for a jumbo mortgage.
- This is handy if you are selling your house. Are you selling a house and buying another? It can be difficult to afford a 20% down payment on the new home if your original home has not yet sold. A piggyback loan can provide those funds until the home sells.
- Interest rates are often adjustable on a HELOC or home equity loan. “It’s unpredictable where rates will go, how the Federal Reserve will raise rates and what that will do with an adjustable rate mortgage in the months ahead,” English said. “That uncertainty is one reason people should be careful with a piggyback ride.”
- You will pay twice the closing costs. With a traditional mortgage, you would only pay closing costs once. But with two mortgages, you pay everything twice.
- You will have two mortgage payments. Until you pay off the second mortgage (which usually has a shorter term than the first), you will make two payments per month. Ask yourself if you can fit this into your monthly budget.
Alternatives to the piggyback loan
Pay for private mortgage insurance
You may prefer to pay for the PMI, especially if it turns out that the PMI would be cheaper each month than a second mortgage payment. Lenders are required to cancel PMI once you have 22% equity in your home, but you can request to cancel it sooner when you reach 20%.
Apply for a jumbo mortgage
If your credit score and debt-to-equity ratio are strong enough to qualify for a giant mortgage, you may prefer to make one payment per month.
Buy a cheaper house
Buying a cheaper home could help you qualify for a conforming mortgage rather than a jumbo mortgage. This would eliminate your need to bypass a jumbo mortgage with a piggyback loan.
A more affordable home might also help you afford a 20% down payment, so paying for the PMI wouldn’t be an issue.
Take out a bridging loan
Are you considering a piggyback loan because you’re moving and haven’t sold your house yet? A bridging loan might be more suitable.
This is a short-term home loan that helps bridge the gap between when you buy your new home and when the finances from selling your original home kick in. You can usually borrow up to 80% of the value of your original home, and the term is six months to a year. You may prefer a bridge loan if you want a second, shorter-term loan so you don’t have to make two mortgage payments for a long time.
Your choice between a piggyback loan and other options will likely depend on your finances and the cost of homes in your area.