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Buying a home is challenging, and the process can stretch your financial resources even in the best of times. That means you’ve got to look for an edge to help you save money, which can be substantial over time.
One of the more popular options for financing is a piggyback loan that can give you the flexibility and the added affordability you need to buy a home in many cases.
Piggyback loans were popular during the housing boom of 2005 and 2006, but many of those loans failed, and banks stayed away from them for several years. However, piggyback loans have returned but with added safeguards built in for many lenders.
Here’s what you should know about this financing mechanism.
What is a Piggyback Loan?
As the name implies, a piggyback mortgage is when you take out two separate loans for the same home. The second loan piggybacks off the first to create enough financing to buy the home.
Terms vary, but typically, the first mortgage is set at 80% of the home’s value, and the second loan is for 10%. The remaining 10% is your out-of-pocket down payment.
Lenders often refer to these loans as an 80-10-10 loan, but with slightly different terms, they can also become an 80-5-15 loan or an 80-15-5 mortgage.
In years past, these were 80-20 loans, but when several underwater defaults occurred, lenders began limiting piggyback loans to a 90% loan-to-value.
Piggyback Loan Pros and Cons
The most common reason people take out piggyback loans is to avoid private mortgage insurance (PMI), which is normally required when a down payment is less than 20%. PMI doesn’t protect you. It protects your lender if you stop making your monthly payments.
PMI costs vary, but you can usually expect to pay anywhere from 0.3-1.5% of your mortgage loan’s original value each year. It is also treated less favorably for tax purposes than interest on a second loan, meaning it makes solid financial sense to avoid PMI whenever possible.
To help borrowers avoid PMI, some lenders build PMI into a loan with a higher interest rate in what’s called lender-paid mortgage insurance. They won’t get a monthly PMI bill, but their second mortgage will be slightly higher than it would be otherwise.
Piggyback loans can also be used to avoid getting a jumbo loan with higher interest rates than conforming loans. A second mortgage can be a cheaper alternative if there is a big enough difference between interest rates for conforming mortgages and jumbo loans.
You must calculate your options and decide which terms save you more money.
Piggyback loans also allow borrowers to come up with less of a down payment. Laying out less cash upfront can be beneficial if you plan on living in the area for a short time and want to avoid tying up more of your money in a house.
Second loans carry a higher interest rate, and for this reason, some borrowers will opt to pay it off faster than the primary loan. For example, if the primary loan is a 30-year mortgage, they may choose a 15-year piggyback loan to pay it off quicker.
Another option might be to choose an adjustable-rate mortgage (ARM) for the piggyback loan to get a lower rate and then pay the balance down quickly before the rate resets.
Your overall monthly payment will be lower with a piggyback loan, but your lender will be originating two loans so that you will pay more in closing costs.
Also, the interest rate on your piggyback loan will usually be higher than the rate on a standard fixed-rate loan. That could mean as much as 1-3% higher in many cases due to more risk for the lender because piggyback loans are in the second position behind the primary mortgage.
If you opt for an ARM, your second mortgage could rise or fall depending on changing economic conditions. You could be stuck paying a lot more if market forces turn against you.
With PMI, when you have paid down your mortgage balance to 80% or less of your home’s original appraised value, your lender must cancel PMI.
» MORE: See today’s refinance rates
Interest-Only Piggyback Loans
You can take out a second interest-only loan to further reduce your initial monthly outlay. However, this is somewhat risky and could leave you with a huge payment several years into your loan.
Interest-only piggyback loans come with a draw period usually lasting 10 years. During this time, you will only pay interest on the second loan, meaning you are not paying off the principal.
After the draw period ends, you might be required to make one big payment to pay off that loan. That can be daunting, especially if you can’t refinance a new loan to pay off your piggyback loan.
Jumbo Piggyback Loans
Conforming mortgages backed by Fannie Mae or Freddie Mac limit how much you can borrow. Depending on where you live, in 2024, those amounts for mortgages backed by Fannie Mae and Freddie Mac on one-unit properties will be $766,550 in 2024.
For high-cost areas, the loan limit is $1.149 million. Anything above that is a jumbo mortgage and will charge significantly higher interest rates and fees.
With a jumbo piggyback, you borrow as much as Fannie or Freddie will allow with a lower-rate conforming loan and the balance with a second loan at a higher “jumbo” rate.
To qualify, you’ll need a FICO score of 740 or above, and you’ll still need to come up with at least a 20% down payment, although a few lenders may allow you to put down as little as 10 percent.
A Final Word on Piggyback Loans
Before committing to two home loans, calculate how much you’re saving, if at all. Avoiding PMI is smart when possible, but be sure you don’t pay more to take out first and second loans than you would with mortgage insurance.