Piggyback Loan
A piggyback loan is a sophisticated financing strategy where a homebuyer takes out two separate mortgage loans simultaneously to purchase a single property. This approach, often referred to as an 80-10-10 or 80-15-5 loan, is primarily used to avoid the requirement for Private Mortgage Insurance (PMI).
Purpose and Structure
The fundamental purpose of a piggyback loan is to circumvent the need for PMI, which lenders typically require when a homebuyer’s down payment is less than 20% of the purchase price. By structuring the financing with two loans, the primary mortgage can be kept at or below the crucial 80% loan-to-value (LTV) threshold, thereby eliminating the PMI requirement.
The structure is typically broken down as follows in an 80-10-10 arrangement:
- 80% First Mortgage: The primary loan covers 80% of the home’s purchase price.
- 10% Second Mortgage: A smaller, secondary loan, the “piggyback”, covers an additional 10% of the price. This loan is in a subordinate position to the first mortgage.
- 10% Down Payment: The buyer contributes the remaining 10% as a cash down payment.
Benefits and Risks for Borrowers
While a piggyback loan can offer a path to homeownership with a smaller down payment, it requires careful consideration of its benefits and inherent complexities.
Benefits:
- Avoidance of PMI: The most significant advantage is eliminating the monthly cost of PMI, which does not contribute to building equity. This can lead to a lower monthly housing payment.
- Potential Tax Deductibility: The interest paid on both the first and second mortgages may be tax-deductible, while PMI premiums are typically not. (Consult a tax professional for specific advice).
- Financing Larger Purchases: It can enable buyers to purchase a more expensive home than they might otherwise qualify for, without having to save for a full 20% down payment.
Risks:
- Complexity of Two Loans: Managing two separate mortgage payments can be more complicated than managing a single one. Each loan has its own terms, and the second mortgage often carries a higher interest rate than the first.
- Variable Interest Rate on Second Mortgage: The piggyback loan is frequently a Home Equity Line of Credit (HELOC) with a variable interest rate. If market rates rise, the payment on this second loan can increase, impacting affordability.
Refinancing Challenges: Having two mortgages can make refinancing more complex. The holder of the second mortgage must agree to subordinate their lien to the new primary mortgage, which can involve additional administrative steps and fees.
