Piggyback loans are back. Should you jump on?
Piggyback loans, second mortgages that allow you to buy a house with little or no down payment, are back after all but disappearing following the housing collapse.
But gaining approval for one is considerably more difficult than it was last decade, when banks handed out these loans with less scrutiny and lots of folks ended up defaulting.
Wells Fargo, for example, says it requires a borrower to make a 15% down payment but will cover the remaining 5% with a second mortgage. That's a significant departure from the days when lenders offered piggyback loans with no down payment.
The advantage of a piggyback loan is that it allows borrowers to avoid paying for private mortgage insurance, which protects a lender if you default and is typically required on a loan with a down payment of less than 20%.
If you're trying to buy a home and don't have enough cash for a 20% down payment, you’ll need to figure out whether a piggyback loan or PMI makes the most sense.
Let’s take a look at the math — and the risks.
Her are several examples comparing PMI to a piggyback loan on a $250,000 home purchase.
In these comparisons, our fictional borrower has a credit score of 720. In each case, the borrower's first mortgage is a 30-year, fixed-rate loan with a mortgage interest rate of 4.66%, which is the average cost of this type of loan in the second week of July.
Piggyback Loan Vs. Private Mortgage Insurance
|Option||Down Payment||1st Mortgage Payment||PMI or 2nd Mortgage Payment||Total Payment|
|PMI with 10% down||$25,000||$1,162||$92 for PMI||$1,254|
|PMI with 5% down||$12,500||$1,226||$133 for PMI||$1,359|
|Piggyback with 10% down||$25,000||$1,032||$138 for variable-rate loan||$1,170|
|Piggyback with 5% down||$12,500||$1,032||$315 for fixed-rate loan||$1,347||Sources: Residential Finance and Silverton Mortgage Specialists|
In the above examples, a borrower would save about $56 per month over the next-best option by using the piggyback loan with a 10% down payment. The second mortgage is financed using a variable-rate home equity line of credit at 5.24%.
A variable-rate loan is typical for a piggyback mortgage.
The HELOC loan has closing costs of $200 to $400, a $50 annual fee and a $475 early termination fee if closed within the first three years, says Mike Corrigan, vice president of sales in the Tampa office of Columbus, Ohio-based Residential Finance, which operates in 38 states.
The monthly payment is smaller, but depending on how long you take to pay back the piggyback loan, this option could be more expensive in the long run.
The loan’s interest-only period lasts for 10 years.
Then, over the next 20 years, you’ll have to pay back the principal, and you’ll still owe interest until the loan is paid off.
The interest rate is variable and is more likely to go up than down because these loans are about as cheap as they can get today. A rate increase could make the loan far more expensive.
You can avoid that risk with a fixed-rate piggyback loan, which some lenders offer, but it will probably cost you more, at least at first. We show an example of the fixed-rate option in the chart above.
It's also important to note that credit, income and loan-to-value can alter both the interest rate on the second mortgage and the cost of PMI, so it's best to work with an experienced lender to find the right option for you.
But, remember, you can usually cancel mortgage insurance once you have 20% equity in your home; you're stuck with the piggyback loan until you pay it off.
And with piggyback loans, all the usual warnings about taking out a home equity loan apply. In this case, you're using the loan to buy the house instead of to finance renovations, but the same risk of foreclosure applies if you can't pay the bill.
There are two special situations where a piggyback mortgage might be your best option:
- Use it to avoid FHA mortgage insurance. New FHA guidelines have made FHA mortgage insurance more expensive. Borrowers also have to pay it for the life of the loan, unlike PMI.
- Use it to avoid a jumbo loan. A piggyback loan may be an option for a borrower who wants a conforming loan but needs to borrow slightly more than the conforming loan limit (typically $417,000).
"Jumbo loans typically require 20% down, and the rates are higher," says George Beylouny, a branch manager at Atlanta-based Silverton Mortgage Specialists, which sells loans in six Southern states. Getting a first mortgage for $417,000 and a second mortgage for the rest would be much cheaper than the jumbo mortgage and would require only 10% down.