Mortgage BasicsWhat is a Piggyback Loan

What is a Piggyback Loan

A swiftly changing real estate market may shift the timing of your home purchase. If waiting to save up a larger down payment could result in missing out on a chance to bid on homes in your price range, you may want to explore financing options. A piggyback mortgage allows you to buy a home with a lower down payment amount. Piggyback loans may also assist buyers of higher-priced homes.

How does a second mortgage work?

A second mortgage can help you bridge the gap if you fall short on your down payment. Similar to a primary mortgage, a second mortgage loan uses your house as collateral. The key difference is that the second mortgage loan has subordinated debt.

If you default on your mortgages, the secondary mortgage lender won’t receive any payments until you satisfy the first mortgage. Secondary mortgage lenders, therefore, accept a higher risk when they lend out this kind of loan, as they will have to supplement a loss more than a primary mortgage lender. To compensate them for the added risk, lenders charge higher interest rates for secondary mortgages than primary mortgages.

What is a piggyback loan?

A piggyback mortgage is a second mortgage that typically closes simultaneously with the first mortgage. The piggyback loan helps borrowers buy a home by providing the necessary funds to cover situations like a down payment shortfall. Homebuyers who do not have the financing to cover a down payment can acquire a piggyback mortgage with a higher interest rate than their primary mortgage to ensure they afford the home.

Why else may a homebuyer use a piggyback loan?

Borrowers can also use piggyback loans instead of acquiring a jumbo loan. In 2022, a jumbo loan categorizes as one for more than $647,200, meaning any homebuyer who needs financing for more than that amount will need a jumbo loan with a high-interest rate. In a market like New York City, where the median price of a home hits $869,000, many homebuyers would likely need this high-interest loan to acquire a home.

Therefore, homebuyers may instead acquire a low-rate first mortgage and a smaller, higher-rate second mortgage. Both loans together may produce a better-combined rate than paying the interest on a jumbo mortgage covering the entire owed amount.

What are the terms of a piggyback loan?

Piggyback mortgage lenders typically offer an 80-10-10 configuration. The first mortgage covers the first 80% of the home price, a piggyback loan covers 10%, and the final 10% represents the buyer’s down payment. Homebuyers can acquire other splits, such as an 80-15-5 configuration. Those looking for a condominium may use a 75-15-10 option.

The most common piggyback loans include home equity loans or HELOC, which are home-equity lines of credit. Borrowers can pay down a HELOC balance, but the line of credit remains open for borrowers to use for future financing needs.

Where can you get a piggyback mortgage?

Ask your mortgage lender if they offer piggyback mortgages. Some lenders will not provide the first and second mortgages for the same property. In this case, you can ask for a referral to another lender for your second mortgage.

Pros of Piggyback Mortgages

There are several reasons homebuyers may choose to borrow a piggyback mortgage, as they offer the following benefits:

Allows you to buy sooner

If you want to purchase property but have not saved enough money to afford your down payment, taking out a piggyback mortgage can help you accomplish your goal sooner. With rising interest rates, homebuyers may be weary of waiting longer to purchase a home as they lose 6% of their purchase power with ever 0.5% interest rate increase. Therefore, they may buy now to avoid losing more purchase power down the road.

Increases the amount you can borrow

Combining the first mortgage with a piggyback mortgage instead of taking out a jumbo mortgage loan may be an option to consider, depending on the interest rates that each loan offers. A piggyback loan also allows you to purchase a home when you cannot provide a large enough down payment by giving you access to additional financing.

If you save up for a down payment within your budget but then come across a dream home at a higher price point, you can decide to take on the second mortgage to stretch your budget.

Eliminates PMI

When using a piggyback loan, you’ll meet the down payment requirements needed to avoid purchasing private mortgage insurance (PMI). Depending on the size of your loan and the percentage charged by your lender for PMI (typically between .58% and 1.86% of your loan balance), a piggyback loan may save you money.

Cons of Piggyback Mortgages

Those planning to use a piggyback mortgage should consider the following potential drawbacks:

Added costs

Second mortgages generally have higher interest rates than first mortgages, meaning there may be better borrowing options available. Alternatively, you can simply wait until you’ve saved enough for a minimum down payment before buying.

Carrying two mortgages

With two mortgage loans, you’ll need to pay two sets of closing costs. You’ll also need to plan for the additional administration required to track and pay two monthly payments. If you face financial hardship and fall behind on your loans, you must dig yourself out of a larger hole down the line. A second mortgage comes with additional risk, and you will need to adopt a strict payment plan to ensure you make your monthly payments.

Qualification for additional debt

To obtain a piggyback loan, you’ll need to qualify for additional debt. This translates into two separate mortgage applications and approvals. To approve a second mortgage, lenders may want borrowers with a higher credit score compared to applications for a first mortgage.

Alternatives to a Piggyback Loan

Before you apply for a piggyback loan, consider the alternatives:

Larger down payment

If you’re not in a rush to buy, you can save for a larger down payment and avoid a secondary loan. If a family member offers to help out by gifting you funds, plan to provide your lender with a letter from the person gifting the funds confirming that the money was a gift and not a personal loan.

Purchase PMI

In some cases, you may opt to pay for PMI for a short time period rather than taking out a second mortgage. Once your mortgage loan balance falls below 80% of the home’s value, you can request your lender discontinue PMI. Depending on the PMI rate and the principal and interest rates associated with your mortgage, you may find that taking on the mortgage insurance costs less than the principal and interest you would have to pay for the piggyback loan.

First-time homeowner programs

Ask your lender about special programs for first-time homebuyers. You may qualify for additional tax credits, a lower interest rate, or down payment assistance which can help you avoid needing a second mortgage loan. Some first-time homebuyer programs cover most of your down payment, meaning you only have to contribute a small percentage to the purchase.

Conclusion

Piggyback mortgages can prove useful if you wish to acquire a home with a larger purchase price or speed up your buying process. If you’re interested in learning more about home financing options, it’s best to sit down with a lender and discuss which types of loans might work for you. Your lender will help review the costs associated with a piggyback loan and compare this option against other financing possibilities to find the most affordable solution.

Jennifer DiGiovanni

Jennifer DiGiovanni is a freelance writer, an author, and a small business owner. She previously worked in the financial services industry and received an MBA from Villanova University. Jennifer enjoys writing about real estate, small business, personal finance, and home improvement.