What Is Piggyback Mortgage?
A piggyback mortgage is a lending arrangement where a homebuyer takes out two separate mortgage loans simultaneously to purchase a single property. This strategy falls under the broader category of mortgage financing. The primary purpose of a piggyback mortgage is often to reduce or eliminate the need for private mortgage insurance (PMI) or to avoid obtaining a jumbo loan. Typically, the first loan covers the majority of the home's purchase price, such as 80%, while the second, smaller loan "piggybacks" on the first to cover an additional portion, allowing the borrower to achieve a higher loan-to-value ratio without a large down payment.
History and Origin
The concept of a piggyback mortgage gained significant traction, particularly in the early 2000s, as a method for homebuyers to circumvent the requirement for private mortgage insurance. Lenders traditionally require PMI when a borrower puts down less than 20% of the home's purchase price on a conventional mortgage. As early as 2005, piggyback loans were increasingly common in the home buying market as a means for buyers to acquire or refinance a home with a down payment less than 20% but without the necessity of PMI.6 These arrangements offered an alternative to the monthly insurance premiums by converting that cost into an additional loan payment, which, unlike PMI, could offer tax-deductible interest in some cases.5
Key Takeaways
- A piggyback mortgage involves two loans taken out concurrently for the purchase or refinance of a single property.
- Its main appeal is often to avoid private mortgage insurance (PMI) by effectively increasing the borrower's equity stake at the time of purchase.
- Common structures include an "80-10-10" setup, where the first mortgage covers 80%, the second covers 10%, and the buyer provides a 10% down payment.
- The second loan in a piggyback arrangement typically carries a higher interest rate than the first mortgage.
- While avoiding PMI, borrowers must account for two sets of closing costs and potentially less flexible refinancing options.
Interpreting the Piggyback Mortgage
A piggyback mortgage is interpreted as a strategic financing tool for homebuyers who may not have the traditional 20% down payment but wish to avoid the additional cost of private mortgage insurance. It essentially splits the financing into a senior lien and a junior lien, allowing the borrower to finance a larger portion of the home's value without the perceived hurdle of PMI. The structure also allows some buyers to stay within conforming loan limits, thus avoiding the stricter requirements often associated with jumbo loan financing. Understanding the total cost, including two sets of loan terms and potential varying interest rates, is crucial for assessing its financial viability.
Hypothetical Example
Consider a homebuyer, Sarah, who wants to purchase a home priced at $400,000. Sarah has saved $40,000 for a down payment, which is 10% of the home's value. Traditionally, with a 10% down payment on a conventional mortgage, she would need to pay private mortgage insurance (PMI).
To avoid PMI, Sarah opts for an 80-10-10 piggyback mortgage:
- First Mortgage (80%): She secures a primary mortgage for $320,000 (80% of $400,000). This loan typically has a lower interest rate.
- Second Mortgage (10%): Concurrently, she takes out a second loan, such as a home equity loan, for $40,000 (10% of $400,000). This loan usually has a higher interest rate and a shorter repayment term.
- Down Payment (10%): Sarah contributes her $40,000 savings as the down payment.
In this scenario, the combination of the two loans and her cash down payment covers 100% of the home's purchase price, with the total loan-to-value effectively at 90% via the first mortgage and the second, without triggering the PMI requirement.
Practical Applications
Piggyback mortgages are primarily applied in residential real estate transactions where borrowers aim to optimize their financing structure. A key application is enabling homebuyers to purchase a property with less than a 20% down payment while avoiding the recurring cost of private mortgage insurance (PMI). Instead of paying an insurance premium that protects the lender, the additional payment goes towards the principal and interest of the second loan, building home equity faster.
Another practical use is for homebuyers purchasing high-value properties that exceed "conforming loan limits." By splitting the financing into two loans, the main mortgage can remain within conforming limits, allowing the borrower to avoid the stricter underwriting requirements and potentially higher interest rates associated with a jumbo loan. The Federal Reserve's monetary policy, while not directly setting mortgage rates, can indirectly influence the overall housing market and the attractiveness of various mortgage products, including piggyback loans, through its impact on broader economic conditions and interest rate trends.4
Limitations and Criticisms
While a piggyback mortgage can offer benefits, it also comes with notable limitations and criticisms. A primary drawback is the increased complexity and potential for higher overall costs. Because borrowers are taking out two separate loans, they typically incur two sets of closing costs, which can diminish any savings from avoiding PMI. The second loan, whether a home equity loan or a Home Equity Line of Credit (HELOC), often carries a higher interest rate and a shorter repayment period than the primary mortgage, leading to higher monthly payments and a greater debt burden.3
Another significant risk is the potential for foreclosure. If a borrower defaults on either the first or second loan, the home can be foreclosed upon, putting the borrower's homeownership at risk.2 The second mortgage lender holds a junior lien position, meaning in a foreclosure sale, the primary lender is paid first. If there isn't enough money left from the sale, the second lender may pursue legal action against the borrower. Additionally, securing a piggyback mortgage can involve stringent qualification criteria, including evaluations of the borrower's credit score and debt-to-income ratio.1 Potential difficulties in refinancing also exist, as the second-lien holder must agree to subordinate their position, which is not always guaranteed.
Piggyback mortgage vs. Second Mortgage
The terms "piggyback mortgage" and "second mortgage" are often used interchangeably, leading to some confusion, but there's a key distinction in context. A piggyback mortgage specifically refers to two loans taken out at the same time for the initial purchase of a home. The second loan in a piggyback arrangement is a type of second mortgage, such as a home equity loan or a Home Equity Line of Credit (HELOC), but its defining characteristic in this context is its simultaneous origination with the primary mortgage to avoid PMI or a jumbo loan.
In contrast, a broader second mortgage is any loan secured by a property that already has a primary mortgage. This could include a home equity loan or HELOC taken out years after the initial home purchase to finance renovations, debt consolidation, or other needs, where the borrower taps into accumulated home equity. So, while the second component of a piggyback mortgage is a second mortgage, not all second mortgages are part of a piggyback financing structure. The distinction lies in the timing and primary purpose of the loans.
FAQs
What is the most common piggyback mortgage structure?
The most common piggyback mortgage structure is known as an "80-10-10." This means the first mortgage covers 80% of the home's value, the second mortgage (the "piggyback" loan) covers 10%, and the homebuyer provides a 10% down payment. Other variations, like 80-15-5, also exist.
Why would someone choose a piggyback mortgage?
People often choose a piggyback mortgage primarily to avoid paying private mortgage insurance (PMI), which is typically required when a homebuyer puts less than 20% down on a conventional loan. It can also be used to avoid needing a jumbo loan for high-priced properties.
Are piggyback mortgages riskier than traditional mortgages?
Piggyback mortgages can carry additional risks because they involve two separate loans, potentially with different interest rates and repayment terms. This can lead to higher total monthly payments and potentially greater financial strain. Failure to make payments on either loan can result in foreclosure.