The Return of Piggyback Loans
Taking out two mortgages on the same house simultaneously may sound like a bad idea at first glance, but "piggyback loans" are a common way to make a smaller down payment or avoid paying mortgage insurance.
As home values start to pick up again, so do the number of piggyback loans, also called second mortgages. The second loans are either a home equity loan or line of credit.
After losing favor in the housing crisis, piggyback loans are returning. In its 2014 annual real estate lending survey, the American Bankers Association reports that 3.1 percent of loans originated in 2013 were piggyback mortgages, up from 1.1 percent in 2011.
PMI most common reason
A second mortgage is typically taken out to avoid private mortgage insurance, or PMI, says Mike Venable, head of underwriting for retail bank operations in the U.S. for TD Bank, in Mount Laurel, N.J.
PMI is typically required by lenders when the down payment is less than 20 percent. While PMI used to not be tax deductible, as mortgage interest is, now up to $100,000 of a second mortgage is tax deductible.
Someone putting only 10 percent down on a $200,000 home, for example, would pay PMI of $798 per year, or $66 a month, on a $180,000 loan, Venable says.
"Most people who have the ability to avoid PMI - they want to do it," he says.
A piggyback loan of 10 percent is the most common amount to avoid PMI, he says. That's typically called an 80-10-10 loan, meaning 80 percent is for the first mortgage, 10 percent for the second mortgage, and a 10 percent down payment. Some lenders allow 80-15-5, with a 15 percent piggyback loan, he says.
A combined loan-to-value of 90 percent on the first and second mortgages is as high as most banks will go, requiring at least a 10 percent down payment.
Piggybacks of 80-20 - where 80 percent of the mortgage is through a primary mortgage and 20 percent is a secondary mortgage where no down payment is required - are not available now as they were during the housing crisis.
Some piggyback loans have a FICO lending score floor of 660, though some raise it to 680, Venable says.
"It's not terrible, but it's not a glamorous FICO score," he says.
To help borrowers avoid PMI, some lenders build PMI into a loan with a higher interest rate in what's called lender-paid mortgage insurance, says Bob Melone, a loan officer at Radius Financial Group Inc. in Norwell, Mass. They won't get a monthly PMI bill, but their second mortgage will be slightly higher than it would be otherwise.
Melone gives the example of adding half a point to a $500,000 loan by a bank paying a PMI company $7,500. Instead of having a 4.25 percent mortgage, the borrower pays 4.5 percent and their monthly mortgage payment increases $60, he says.
Piggyback loans can also be used to avoid getting a jumbo loan - typically $417,000 and also called a conforming loan limit.
"A second mortgage might allow someone to avoid costly jumbo loan interest rates," Melone says.
There has to be a big enough difference between interest rates for conforming mortgages and jumbo loans to make a piggyback loan worthwhile for this reason.
Coming up with less of a down payment is another top reason to get a piggyback loan. Having less "skin in the game" can be beneficial if you don't plan on living in the area for long and don't want to tie up more of your money in a house, Venable says.
Higher costs of piggybacks
One big downside to second mortgages is that interest rates for the fixed-term loans of five to 30 years are half a point to three points higher than the first mortgage, Melone says.
"The reason that the rates are higher is that for the lender, the risk is greater," he says.
Piggyback loans are in the second position behind the primary mortgage, Melone says, meaning the lender for the second mortgage may not get all of its money back if the loans are foreclosed on and the home is sold.
For example, a $400,000 first mortgage and a $100,000 second mortgage on a home where the down payment was $55,000 and the home sold for $555,000, the second mortgage lender would take a bigger loss if the home lost value, was foreclosed on and was sold by the bank for $450,000, he says.
Of that $450,000, the primary mortgage holder would get its $400,000 back and the second lender would only get $50,000 back, or half of the piggyback loan amount.
"It's a super, incredible risk," Melone says of second mortgage lenders.