When it comes to financing a home purchase, borrowers often explore various options to find the most suitable and affordable solution. Piggyback loans, also known as combo loans or 80-10-10 loans, have gained popularity as an alternative way to structure a mortgage and avoid the costs associated with private mortgage insurance (PMI). If you’re considering purchasing a home and want to learn more about piggyback loans and how they work, you’ve come to the right place. In this comprehensive guide, we will explore what piggyback loans are, how they can benefit borrowers, the different types available, and important considerations to keep in mind.
What are Piggyback Loans?
What is Piggyback Loans? Piggyback loans are a type of mortgage financing that involves taking out two separate loans to avoid the need for private mortgage insurance (PMI). Typically, when a borrower takes out a mortgage loan that exceeds 80% of the home’s value, lenders require them to pay for PMI. PMI is designed to protect the lender in case the borrower defaults on the loan, but it adds an extra cost to the borrower’s monthly mortgage payments.
Piggyback loans aim to bypass the requirement for PMI by splitting the primary mortgage into two parts: a first mortgage for 80% of the home’s value, and a second mortgage or home equity line of credit (HELOC) for the remaining amount. The combined loan-to-value (CLTV) ratio of both loans should still be within acceptable limits for the lender. The borrower typically makes a down payment of at least 10% of the home’s value, although other variations of piggyback loans are available with different down payment requirements.
The most common piggyback loan structure is known as the 80-10-10 loan. In this scenario, the borrower contributes a 10% down payment, obtains an 80% first mortgage, and secures a second mortgage for the remaining 10%. However, there are other variations, such as the 80-15-5 loan, where the borrower puts down a 5% down payment, obtains an 80% first mortgage, and secures a second mortgage for 15%.
Benefits of Piggyback Loans
Piggyback loans offer several benefits for borrowers, including:
Avoidance of Private Mortgage Insurance (PMI)
The primary advantage of piggyback loans is the ability to avoid paying for private mortgage insurance. PMI can significantly increase monthly mortgage payments, adding a substantial cost over the life of the loan. By splitting the mortgage into two parts, borrowers can secure the necessary financing while bypassing the need for PMI.
Potential Savings
By avoiding PMI, borrowers can potentially save a significant amount of money over the course of their loan. The cost of PMI typically ranges from 0.5% to 1% of the loan amount annually. By eliminating this expense, borrowers can allocate those funds toward other financial goals or enjoy lower monthly mortgage payments.
Enhanced Affordability
Piggyback loans can make homeownership more affordable for borrowers who may not have a 20% down payment saved. By spreading the loan over two mortgages, borrowers can secure financing with a smaller down payment and still meet the lender’s requirements. This allows more individuals and families to enter the housing market and achieve their homeownership goals.
Flexibility in Loan Structure
Piggyback loans offer flexibility in structuring the mortgage. Borrowers can choose from different combinations of first and second mortgages based on their financial situation and preferences. This flexibility allows borrowers to tailor the loan to their needs and financial goals.
Potential Tax Benefits
The interest paid on both the first and second mortgages of a piggyback loan may be tax-deductible, subject to certain limitations and tax regulations. Borrowers should consult with a tax professional to understand the specific tax advantages available to them.
Types of Piggyback Loans
Piggyback loans come in different variations, depending on the specific loan structure and down payment amount. Here are some common types:
80-10-10 Loan
The 80-10-10 loan is the most common piggyback loan structure. The borrower provides a 10% down payment, secures an 80% first mortgage, and obtains a second mortgage for the remaining 10%. This structure allows the borrower to avoid PMI and provides more favorable terms than financing the entire amount with a single mortgage.
80-15-5 Loan
In the 80-15-5 loan structure, the borrower puts down a 5% down payment, obtains an 80% first mortgage, and secures a second mortgage for 15%. This option is suitable for borrowers who have a smaller down payment but still want to avoid PMI.
75-15-10 Loan
The 75-15-10 loan structure involves a 10% down payment, an 75% first mortgage, and a second mortgage for 15%. This variation allows borrowers to secure financing with a lower down payment while still avoiding PMI.
It’s important to note that the availability of these loan structures may vary depending on the lender and individual borrower qualifications. Working with a mortgage broker or loan officer can help borrowers explore the best options for their specific circumstances.
Considerations for Piggyback Loans
While piggyback loans offer benefits, borrowers should consider the following factors:
Higher Interest Rates on Second Mortgage
Second mortgages, such as those used in piggyback loan structures, often come with higher interest rates compared to first mortgages. Borrowers should carefully evaluate the interest rates, terms, and potential long-term costs associated with the second mortgage.
Impact on Debt-to-Income (DTI) Ratio
When considering a piggyback loan, borrowers should assess their debt-to-income ratio (DTI). The total monthly payments for both the first and second mortgages will contribute to the borrower’s overall DTI ratio. Lenders typically have specific requirements regarding DTI ratios, and borrowers should ensure they meet these criteria to qualify for the loan.
Qualification Requirements
Borrowers will still need to meet the lender’s qualification requirements for both the first and second mortgages. Lenders will assess factors such as credit history, income stability, employment history, and the borrower’s ability to repay both loans.
Property Value and Loan-to-Value (LTV) Ratio
Lenders will consider the appraised value of the property and the combined loan-to-value (CLTV) ratio when evaluating the loan application. The CLTV ratio includes both the first and second mortgages. Borrowers should ensure the property value aligns with the loan amounts and CLTV ratio requirements of the lender.
Long-Term Financial Planning
Borrowers should carefully evaluate their long-term financial goals and consider how the piggyback loan will fit into their overall financial plan. It’s essential to assess the potential costs, monthly payments, and long-term financial implications to ensure the loan aligns with their financial objectives.
Conclusion
Piggyback loans provide borrowers with an alternative financing option that allows them to avoid private mortgage insurance (PMI) and potentially save money on their mortgage payments. By splitting the mortgage into two parts, borrowers can secure financing with a smaller down payment while maintaining favorable loan terms. However, borrowers should carefully evaluate the interest rates, qualification requirements, and long-term financial implications associated with piggyback loans. It’s crucial to work with experienced mortgage professionals, such as mortgage brokers or loan officers, who can provide personalized guidance and help borrowers navigate the complexities of piggyback loans. By understanding the intricacies of piggyback loans and conducting thorough research, borrowers can make informed decisions and choose the financing option that best suits their homeownership goals and financial well-being.
