A 20% downpayment can be difficult for many people. But there is an option available for some borrowers: the piggyback loan.
How Piggyback Loans Can Be Your Solution to a Downpayment
What is a Piggyback Loan?
A piggyback loan is a type of mortgage structure that essentially gives the borrower two loans: one for the majority of the home’s value, and the other to cover a required down payment.
So instead of purchasing a home by borrowing 80% of the purchase price and bringing the remaining 20% from personal savings, a piggyback loan would have a primary loan of 80%, and another loan of 20% to cover the downpayment.
Piggyback loans come in different types. One of the most common, which we outlined above, is the 80/20 piggyback loan. However, they are often structured as 80/10/10 loans. In this case, a first mortgage is taken out for 80%, another 10% is brought from a second loan, which usually has a higher interest rate, and a down payment of 10% is brought from the borrower’s savings. This is likely the most common way that piggyback loans are structured.
You can also find piggyback loans that allow you to purchase a home with downpayments as small as 5%. In this case, it would be an 80/15/5 piggyback loan.
By using a piggyback loan, you are able to avoid private mortgage insurance, or PMI. This is an additional payment that is tacked on to most mortgages that have greater than 80% loan-to-value. Essentially, if you can bring a 20% down payment, and borrow the remaining 80%, you will avoid PMI. However, if you have a 10% downpayment, and have to borrow 90%, you’ll likely have to pay PMI, which helps reduce the risk of default to lenders.
PMI is usually less than $70 a month, depending on the size of the loan. This may not seem like much, but if you are paying PMI for a full year, it can be over $800 annually. In most cases, PMI will disappear once you reach 20% equity, but it will stick around for the life of the loan on some types of mortgages.
Piggyback loans, by allowing you to borrow the amount needed to reach 80% equity (at least as far as the first loan is concerned), allow you to avoid mortgage insurance. This can be a benefit to many borrowers, but they do have drawbacks, and they may not be for every borrower.
Benefits of Piggyback Loans
As we’ve discussed, the biggest benefit of a piggyback loan is avoiding PMI. If you don’t have a downpayment, which is a significant upfront cost for most borrowers, piggyback loans can help you avoid the added cost of mortgage insurance.
Piggyback loans may also open certain housing options for some borrowers. Perhaps you have a house in mind that you simply can’t afford if a 20% downpayment were required. With a piggyback loan, you might be able purchase this house at a monthly price that you can afford.
Drawbacks of Piggyback Loans
Depending on the specifics of your situation, using a piggyback loan can actually be more expensive than simply paying PMI.
First of all, you will basically be taking out two loans, so there will be two closing costs, which means you’re paying double for loan origination and processing fees. If you are close to the 20% mark, it may actually be more affordable to simply pay the PMI and not finance the remaining total. (This assumes, of course, that PMI will disappear after you reach 80% equity.)
Another downside of a piggyback loan is that the second mortgage will likely carry a high interest rate. Lenders can offer different options, so it never hurts to shop around, but if you find that interest rates are significantly higher, they may actually cost you more than PMI.
Another drawback is that the second loan, with it’s higher interest, won’t go away until it’s paid off. Depending on your repayment plan, it could last longer than your PMI, which basically means you’ll be making the extra payments longer.
If your piggyback loan is still around and you try to refinance, you could run into trouble. In most cases, the lender on a second loan will have to take a backseat to any other loans. If you can’t get the holder of the piggyback to agree to be secondary, you may be unable to refinance.
A final disadvantage is that you may have to make two payments every month. Piggyback loans are often structured separately, so you will need to make two payments every month, which can complicate your monthly expenses and budgeting.
Is a Piggyback Loan Right for Me?
So after learning about piggyback loans and reviewing their positives and negatives, is this loan product right for you? While each person will have a unique situation, there are some universal factors that might indicate if a piggyback loan could be the right choice for your needs.
First of all, if you have almost no downpayment whatsoever, it could be a good option. If you have a large down, but not quite 20%, you may consider a piggyback loan, but it may not be ideal because you would only pay PMI for a short time. Essentially, you need to consider how long you will be paying PMI and weight that against the cost of the piggyback loan.
The price of the home you want to purchase is also an important factor. If the home you will buy is relatively expensive, piggyback loans may help you get the affordable financing you need. For example, if you are going to need a jumbo loan to finance your purchase, but you don’t have a large downpayment, piggyback loans could be your best option.
Your credit can also be a factor. You will need a strong credit score to qualify for a piggyback loan; if your credit is low, it may not even be an option.
Guiding You Through a Piggyback Loan Purchase
If you need help weighing the benefits of a piggyback loan, let the team at San Diego Purchase Loans be your guide. We’ll help you understand all the factors involved in these loan options, allowing you to make a confident decision on your next mortgage.