Piggyback loans are appropriately named – they’re basically second mortgages secured at the same time as the first mortgage on a home purchase. Essentially, the second mortgage “piggybacks” the first.
This combo was commonly used years ago, but lost its steam when the financial crisis hit. But as the housing market has since continued to build back up, they’re making a comeback.
Piggyback Loans Defined
Piggyback mortgages are also known as “80-10-10” mortgages because of how the purchase price is covered. In this scenario, the homeowner takes out a primary mortgage and a second mortgage or home equity line of credit (HELOC) that equals 80 percent, and 10 percent of the home’s value, respectively.
These numbers aren’t always fixed, however. You can even get an 80/15/5, a 75/15/10, or whatever combination that the lender will agree to.
The first number refers to the percentage of the home’s value that the first mortgage will cover. The second number refers to the percentage of the sale price that the second mortgage, home equity loan, or the HELOC will cover. And the last number refers to how much the homeowner needs to come up with for a down payment.
This is where the name “piggyback” comes from – the second mortgage piggybacks on top of the first.
Basically, you’re taking out two mortgages at once, with the second mortgage being in the form of a home equity loan or line of credit. These loans are usually pegged to the prime rate (the lowest available rate of interest). Considering the fact that rates vary, so can the piggyback loan’s monthly payment.
The majority of these loans have a draw period of around 10 years, during which only interest payments are due. Once the draw period expires, the outstanding principal will either be amortized over a time period of up to 20 years, or due in a lump sum payment.
How Can a PiggyBack Loan Save You Money?
The main reason that borrowers tap into piggyback loans is to avoid paying private mortgage insurance (PMI). This insurance payment is required if you can’t come up with at least 20 percent of the home purchase for the down payment. It protects lenders in the event that homeowners default on their mortgage – causing the home to enter foreclosure – and the value of the property drops to the point that the sale will not cover the original mortgage.
If, for instance, the loan-to-value ratio (LTV) is 85 percent, the borrower must then pay PMI that’s incorporated into their monthly payments. By taking out a piggyback loan, the lender with the 80 percent loan will have satisfied their risk, and won’t charge PMI. Avoiding this cost can put a good chunk of change back in your pocket.
Lenders consider the second mortgage as a totally separate part of the home buying transaction. They let it count towards your down payment. With 10 percent down in cash and a 10 percent second mortgage, you’ve got your 20 percent down, and successfully avoided having to be stuck with paying PMI.
Another major consideration? The tax treatment – the interest paid on a piggyback mortgage is tax deductible up to $100,000.
Piggyback loans are great for borrowers who are savvy and disciplined enough to make sure the principal is also paid down. It’s also best for borrowers who have a decent level of risk tolerance for volatile interest rates. As always, have chat with your mortgage specialist to find out if you can swing a piggyback loan to avoid paying those extra pesky PMI fees.