When it comes to purchasing a home, many borrowers find themselves searching for creative ways to structure their financing. One such option is the piggyback loan program. Also known as a “combo” or “80-10-10” loan, a piggyback loan involves taking out two separate loans to avoid paying private mortgage insurance (PMI) and potentially secure better terms. In this article, we will delve into the details of piggyback loans, their benefits, considerations, and how they can be a viable alternative for homebuyers.
What is a Piggyback Loan?
A piggyback loan is a financing option that involves taking out two separate loans simultaneously during the homebuying process. The first loan covers 80% of the home’s purchase price, and the second loan covers an additional percentage (typically 10% or 15%). The remaining portion, usually 10% or 15%, is paid as a down payment by the borrower.
The purpose of a piggyback loan is to avoid paying private mortgage insurance (PMI), which is typically required for conventional loans with a down payment of less than 20%. By utilizing a piggyback loan, borrowers can achieve a combined loan-to-value (CLTV) ratio of 80%, thus eliminating the need for PMI.
How Does a Piggyback Loan Work?
To better understand how a piggyback loan works, let’s consider an example:
- First Mortgage: The borrower takes out a traditional mortgage from a lender, covering 80% of the home’s purchase price. This loan serves as the primary mortgage and is typically a fixed-rate or adjustable-rate mortgage.
- Second Mortgage: Simultaneously, the borrower secures a second loan, often referred to as a piggyback loan or a home equity line of credit (HELOC). This loan covers the remaining portion of the home’s purchase price, such as 10% or 15%. The second loan usually has a higher interest rate and a shorter repayment term.
By structuring the financing in this way, borrowers can avoid paying PMI, which can result in significant savings over time.
Benefits of Piggyback Loans
Piggyback loans offer several benefits for homebuyers:
Avoidance of PMI
One of the primary advantages of piggyback loans is the ability to avoid paying private mortgage insurance (PMI). PMI can add a significant amount to monthly mortgage payments, and by eliminating it, borrowers can save money over the life of the loan.
Enhanced Buying Power
Piggyback loans can enhance a borrower’s buying power by allowing them to make a smaller down payment. This can be particularly beneficial for homebuyers who have limited funds available for a down payment but still want to purchase a property.
Potentially Lower Interest Rates
Since the first mortgage typically covers 80% of the home’s purchase price, it may qualify for more favorable interest rates compared to loans with higher loan-to-value ratios. This can result in lower monthly mortgage payments for the borrower.
Flexible Repayment Options
The second mortgage in a piggyback loan program is often structured as a home equity line of credit (HELOC). This provides borrowers with flexibility in how they choose to repay the loan. They can make interest-only payments during the draw period or pay down the principal along with the interest.
Considerations for Borrowers
While piggyback loans offer advantages, borrowers should also consider the following factors:
Higher Interest Rates on the Second Loan
The interest rate on the second mortgage or piggyback loan is typically higher compared to the first mortgage. Borrowers should carefully evaluate the interest rates, repayment terms, and potential long-term costs associated with the piggyback loan.
Additional Debt and Repayment Obligations
Taking out a piggyback loan means having an additional debt obligation in the form of the second mortgage. Borrowers should consider their overall financial situation and ensure they can comfortably manage both mortgage payments along with their other financial responsibilities.
Borrowers must meet the qualification requirements for both the first mortgage and the second mortgage. Lenders will evaluate the borrower’s creditworthiness, income stability, and debt-to-income ratio for both loans. Meeting the eligibility criteria for both loans can be more challenging compared to a single loan application.
Market Conditions and Future Plans
Borrowers should also consider market conditions and their future plans when considering a piggyback loan. For example, if interest rates are high, it may impact the overall cost of the loan. Additionally, if borrowers plan to sell the property or refinance in the near future, they should evaluate the potential impact on the piggyback loan.
Piggyback loans can be a viable alternative financing option for homebuyers looking to avoid private mortgage insurance (PMI) and structure their financing creatively. By taking out a first mortgage and a second mortgage simultaneously, borrowers can enhance their buying power, potentially secure better interest rates, and save money on PMI. However, it’s essential for borrowers to carefully evaluate the interest rates, repayment terms, and qualification requirements of both loans. Working with a knowledgeable mortgage professional can provide valuable guidance throughout the piggyback loan process, helping borrowers make informed decisions that align with their financial goals and circumstances.