Is a Piggyback Loan a Good Idea?
Piggyback loans are a way for buyers to get into a piece of real estate with little down, and to avoid paying for mortgage insurance. This is done by taking out a mortgage loan to purchase a house and another loan—a piggybacked loan—to cover the down payment. As default rates on mortgages soared during the housing market collapse, riskier piggyback loans all but vanished from the market, but some lenders are making them available again.
How does a piggyback loan work?
A piggyback loan is a second mortgage used to make a down payment on a home when the buyer hasn't saved a lot of money to put down. It's like taking out a home equity loan on the house as it is being purchased. It allows buyers a way to avoid paying private mortgage insurance (PMI) over the course of the loan, but the loan amount is higher, Thus, the amount the buyer can save by avoiding PMI will vary based on the total amount borrowed. Getting a piggyback loan may not always be cheaper than paying for PMI.
In the past, many piggyback loans, also called 80/20 loans, would cover the entirety of a 20 percent down payment. This contributed to defaults by buyers who took on more than they could afford. Post-housing crash, lenders have tightened up the standards and now typically require at least 5 percent from the buyer.
What kind of loans are they?
Piggyback loans are usually written as adjustable rate mortgages rather than 30-year fixed-rate home loans. If a bank will offer a fixed-rate mortgage, it is going to come at a higher cost, which could make paying PMI a better alternative. Currently, mortgage interest rates are still very low but rates are expected to go up , so any payment calculations the buyer makes to compare costs should include higher payments due to rising interest rates.
Banks won't approve piggyback mortgages for just anyone, as lenders have learned from the disastrous results of the collapse of the housing bubble. At that time, credit flowed freely and with little verification, factors which fueled foreclosures. Today, borrowers will need to have a credit score of at least 700 and a debt-to-income ratio—or how much is owed versus how much is earned—of 43 percent or less. Buyers will have to show solid proof of stable income, and some banks will apply rules that are more strict. Many banks will not offer piggyback loans at all, so, unlike the days before the housing crash, buyers shouldn't expect an easy approval process if they want to buy a home with little down.
The home itself will need to be somewhat bargain-priced for a bank to consider a piggyback loan as well. The loan-to-value ratio, or what percent of the home's value will be financed, will probably need to be at least 85 to 90 percent. In other words, the home should still be worth 10 to 15 percent more than the total amount of both the home loan and the piggyback loan for a bank to consider piggyback financing.
Is a piggyback loan a good idea?
Piggyback loans can be risky for the buyer as well as the bank. A buyer with little down represents a higher risk as a potential defaulter to the bank. For the buyer, the risks include paying more over the term of the loan. A piggyback mortgage is only appropriate to take on if the buyer has done the math to see if it will save money over paying for PMI. It is probably only beneficial for home buyers who expect to stay in the home for a long time or buyers who don't expect to refinance any time soon.