Should I get a piggyback loan with my mortgage?
Piggyback loan basics
- Taken out along with your first mortgage
- Count toward the down payment, potentially avoiding mortgage insurance
- Separate closing costs apply
- Often have high interest rates
Lenders often work with borrowers to build mortgages that suit different situations. While lenders expect most borrowers to make a down payment of 20 percent of a home purchase price, those who can’t come up with thousands of dollars in ready cash may consider a piggyback loan to help finance the purchase.
A piggyback loan is a second mortgage that covers a percentage of your home’s purchase price, and generally is counted toward the down payment. It figuratively “piggybacks” onto your first mortgage, effectively breaking the mortgage into two loans. In addition to your down payment, the two loans account for the home’s purchase price.
Why complicate your mortgage by dividing it into two parts? The potential to save money, and lots of it.
How piggyback loans work
Piggyback loans are commonly structured in an 80-10-10 arrangement. The first number — 80 percent — represents how much of your home value the first mortgage covers. The second number — 10 percent — is the value the piggyback loan covers, usually in the form of a variable-rate home equity line of credit (HELOC). The final number — 10 percent — is the money you come up with. There are a number of other percentage arrangements on the market, such as 75-15-10 and 80-5-10. Piggyback loans are often issued by your first-mortgage lender.
A piggyback loan can help you make a larger down payment and avoid paying private mortgage insurance (PMI). Lenders consider 20 percent an acceptable minimum for a down payment. In other words, if you have paid down 20 percent of your home, you are less likely to default. Any less equity raises the risk of default, and lenders require that you purchase PMI, which protects the lender’s money should the borrower default. It is typically 0.3 percent to 1.5 percent of the mortgage loan.
This can add up to a significant cost over the life of the mortgage. For example, if you have a 30-year mortgage on a $400,000 home and make a down payment of 10 percent, PMI will add $162 to your monthly mortgage payments — that’s nearly $2,000 per year until you build the 20 percent equity.
In the eyes of a lender, piggyback loans serve as part of the down payment, helping you reach a loan-to-value ratio of 80 percent or less, so there’s no need for PMI.
Should I get a piggyback loan?
Piggyback loans are not always the most cost-effective option for a borrower. Consider these five questions before signing for a piggyback loan to help finance your home.
- How much could I put into a down payment? A piggyback loan has a price tag: separate closing costs, plus a higher interest rate compared to your first mortgage. While you can eliminate PMI as you make payments and gain equity in your home, the second mortgage remains until you pay off the loan, plus interest. Consider how soon you expect to reach 20 percent equity in your home and compare the cost of paying PMI over that period to the cost of closing and paying interest on a piggyback loan. It may be cheaper to simply pay for PMI on a first mortgage.
- How much is the home purchase price? Piggyback loans can be helpful for homebuyers looking at more expensive properties. In most U.S. counties, a mortgage of more than $424,100 is considered a jumbo loan — and consequently is harder to qualify for. By using a piggyback loan to split up the mortgage into two conforming loans, you may potentially obtain financing with better conditions.
- What tax bracket am I in? Interest on a piggyback loan is tax deductible up to $100,000. PMI is also tax deductible, but only for those with income below $54,500 if single or $109,000 if married. Compare your income and piggyback loan amount to see which option is more cost-effective for you.
- What is my credit score? Strong credit of at least 680 is usually required to qualify for a piggyback loan and get the best interest rates.
- What are the terms of a piggyback loan? Many piggyback loans are structured as variable-rate HELOCs, meaning interest rates change over time — generally upward. Additionally, for the first five to 10 years you have the HELOC, you are typically only required to pay toward the interest. After that initial period, you must start to pay down the principal, in addition to the interest. You’ll need to be prepared to face significantly higher monthly payments when the payback period begins.
A piggyback loan can be a useful way to save money if planned carefully. Instead of making the minimum interest payment each month, use the money saved on PMI to pay down the piggyback principal. A piggyback loan is not a good idea if you simply want to put off payments, as you will accrue significant interest and run the risk of owing more on your home than it is worth. Not all lenders offer piggyback loans either, so be sure to shop around.