A piggyback mortgage is exactly what it sounds like – one mortgage on top of another. This set of two mortgages was commonly used prior to the mortgage crisis to avoid paying private mortgage insurance (PMI), when homebuyers didn’t have a large enough down payment.
Now, this loan combo is much harder to come by. However, it can still be an option for homebuyers with good credit who have at least a 10% down payment and would prefer not to pay PMI.
What Is Private Mortgage Insurance?
If you don’t have a 20% down payment on the home you’re interested in, lenders will generally require that you to pay PMI. This insurance helps protect the lender in the event that your home goes into foreclosure and its value declines to the point that the sale won’t cover the original mortgage.
Since having a larger down payment helps prevent this scenario, you don’t need to pay private mortgage insurance if your mortgage is less than or equal to 80% of your home’s value. Private mortgage insurance hardly benefits you, the borrower, except it can allow you to get into “more” house with less down payment. Otherwise, it’s simply an extra charge that will be tacked onto your monthly mortgage payment.
The amount you’ll have to pay for private mortgage insurance varies depending on how large your loan is, how good your credit is, and how large your down payment is. But a reasonable estimate is that it will cost about 0.5% of your original loan value each year. On a $200,000 loan, that equals $1,000 per year, or $83 per month.
On most loans, PMI can be removed once your home’s loan to value ratio drops below 80%. It’s even tax-deductible for some people. However, avoiding this extra expense will save you money, especially if your income tax bracket is too high to qualify for the PMI tax deduction.
What Is a Piggyback Mortgage?
One method of avoiding PMI is a piggyback mortgage, or an “80-10-10″ mortgage. The numbers reflect how the purchase price will be covered. Specifically, the homeowner will take out both a primary mortgage and a second mortgage or home equity line of credit equal to 80% and 10% of the home’s value, respectively.
Keep in mind, however, that the numbers aren’t necessarily fixed. You can get an 80/15/5, a 75/15/10, or any other combination the lender will allow. This also keeps the primary mortgage at or under 80%.
The first number refers to what percentage of the home’s value the primary mortgage will cover. It must be less than or equal to 80% to avoid PMI.
The middle number refers to the percentage of the purchase price that will be covered by a second mortgage, home equity loan, or home equity line of credit. PMI is not required on this type of loan, but it will carry a higher interest rate than the primary mortgage.
The final number refers to the amount the homeowner will need to kick in as a down payment. Again, it doesn’t have to be exactly 10%, but that amount is common.
Now you can see why this setup is referred to as a “piggyback” mortgage. The second mortgage piggybacks on the first, so that you can qualify for a larger loan without a bigger down payment and still avoid paying PMI.
The following are general pros and cons of a piggyback mortgage. You will have to run your own numbers to determine whether it’s cost-effective to take out a piggyback mortgage or a traditional mortgage that includes PMI.
- Can Purchase a Larger Home. You may qualify for a larger combined loan with this method compared to wrapping both loans into one.
- Lower Monthly Payment. You may save money by avoiding PMI.
- Tax Treatment. The interest on a second mortgage or home equity loan is tax-deductible up to $100,000.
- Small Down Payment. With this method, you can avoid PMI with a 10% or even a 5% down payment.
- Requires Good Credit. You must have solid credit to get this type of loan or for it to make more financial sense than getting a traditional loan with PMI.
- Higher Interest Rate. You will pay a higher interest rate on the second mortgage. In some cases, paying PMI instead of doing two loans could save you money on your monthly payment.
- Closing Costs and Fees. A piggyback loan is often more expensive since you have to pay closing costs and fees on two mortgages instead of one.
- May Not Get Full Tax Benefit. The interest on a second mortgage is only deductible for the part of the loan that is under $100,000. So if your second mortgage is large, you may not get the full tax benefit.
- PMI Is Tax-Deductible. If you fall within income limits set by the IRS and can deduct PMI payments on your taxes, a piggyback mortgage is less likely to be cost-effective.
As with virtually all financial decisions, this one comes down to your situation and how much of a down payment you can afford. For example, if you have a down payment near 20%, you might be better off just accepting a loan with PMI. Though you’ll pay PMI for at least a few months, once your loan balance reaches 80% of the value of your home, you can ask your lender to remove it. This approach could be less expensive than paying a higher interest rate on a second mortgage for many years plus higher closing costs.
Or if your down payment is less than 10%, the interest rate on your second mortgage may be very high and thereby negate any cost savings from avoiding PMI. You’ll also want to consider whether you qualify to deduct PMI on your taxes and if you could deduct all the interest from a second mortgage or only a portion of it.
All this said, the better your credit, the more likely a piggyback mortgage is to work for you. Be prepared to do some research to find a lender who is still willing to write this type of loan.
Would you ever consider getting a piggyback mortgage for your home? Why or why not?
(photo credit: Shutterstock)