A piggyback loan, also known as a "piggyback" second mortgage, is a financial arrangement where a home equity loan or home equity line of credit (HELOC) is taken out at the same time as your main mortgage.
Understanding Piggyback Loans
This type of loan is primarily used to help homebuyers secure a primary mortgage without the added cost of private mortgage insurance (PMI). When a borrower makes a down payment of less than 20% of the home's purchase price, lenders typically require PMI to protect themselves in case the borrower defaults. A piggyback loan allows borrowers with lower down payment savings to avoid this expense.
How a Piggyback Loan Works
The "piggyback" strategy involves structuring the home financing into multiple parts:
- Down Payment: The buyer makes a smaller initial down payment (e.g., 5% or 10% of the home's value).
- First Mortgage: The main mortgage is typically taken for 80% of the home's value. This keeps the loan-to-value (LTV) ratio of the first mortgage at or below 80%, which is the threshold often used by lenders to waive PMI requirements.
- Second Mortgage (Piggyback Loan): This separate loan covers the remaining portion of the home's value, usually 5% to 15%, to complete the financing. It "piggybacks" on the main mortgage.
Example Scenario:
Consider purchasing a home for $400,000.
- Without a Piggyback Loan: If you only have a 10% ($40,000) down payment, you'd borrow $360,000 (90% LTV), likely requiring PMI.
- With a Piggyback Loan (e.g., an 80/10/10 loan):
- You make a 10% ($40,000) down payment.
- Your first mortgage is for 80% ($320,000) of the home's value. This 80% LTV means no PMI on the first loan.
- A piggyback loan (second mortgage) covers the remaining 10% ($40,000).
- In this setup, you have two separate loan payments (first mortgage and piggyback loan) in addition to your down payment, allowing you to avoid PMI.
Key Characteristics
- Simultaneous Origination: Both the first mortgage and the piggyback loan are typically secured at the same time.
- Subordinate Lien: The piggyback loan is a second mortgage, meaning it has a lower priority than the main mortgage in the event of foreclosure.
- Purpose: Its primary aim is to eliminate the need for Private Mortgage Insurance (PMI) for borrowers who cannot afford a 20% down payment.
- Types: The piggyback loan itself can be structured as either a fixed-rate home equity loan or a variable-rate home equity line of credit (HELOC).
By utilizing a piggyback loan, homebuyers can often achieve homeownership with less upfront capital while avoiding the ongoing monthly cost of PMI.
