What is a piggyback mortgage loan & how does it work?

November 8, 2021

At its simplest, a piggyback mortgage can be defined as a second mortgage, typically a home equity loan or home equity line of credit (HELOC).

Piggyback mortgage loans might be a smart option for homebuyers looking to finance a home without a large down payment. They are taken out at the same time as main mortgages and may save homebuyers money over the life of their loans by not having to pay for private mortgage insurance (PMI).

Read on to learn more about what a piggyback loan is and how it works.

What Is a Piggyback Loan?

Homebuyers can use a piggyback mortgage loan to fund the purchase of a property. Essentially, they take out a primary loan and then a second loan, “the piggyback loan,” to fund the rest of the purchase.

Using the strategy helps homebuyers reduce their mortgage costs, such as by not needing a 20% down payment to qualify. It also helps them avoid the need for private mortgage insurance, which is usually required for those who don’t have a 20% down payment.

How Do Piggyback Loans Work?

When appropriate for a homebuyer’s unique situation, a piggyback mortgage might potentially save the borrower in monthly costs and reduce the total amount of a down payment.

Here’s an example to consider of how they work:

Jerry is buying a home for $400,000. He doesn’t want to put down more than $40,000 for the down payment. This eliminates several mortgage types. He works with his lender to secure a first mortgage for $320,000, then another to secure a piggyback mortgage of $40,000, and finishes the financing process with his down payment of $40,000.

Piggyback home loans were a popular option for homebuyers and lenders during the housing boom of the early 2000s. But when the housing market crashed in the late 2000s, piggyback loans became less popular, as a lack of equity proved homeowners more vulnerable to loan defaults.

Fast forward to today’s housing market and piggybacks are starting to become a viable and acceptable option again.

Types of Piggyback Loans

A 80/10/10 Piggyback Loan

There are different piggyback mortgage arrangements, but an 80/10/10 loan tends to be the most common. In this scenario, a first mortgage represents 80% of the home’s value, while a home equity loan or HELOC makes up another 10%. The down payment covers the remaining 10%.

In addition to avoiding PMI, homebuyers may use this piggyback home loan to avoid the mortgage limits standard in their area.

A 75/15/10 Piggyback Loan

A loan with a 75/15/10 split is another popular piggyback loan option. In this case, a first mortgage represents 75% of the home’s value, while a home equity loan accounts for another 15%. And like the 80/10/10 split, the remaining 10% is the down payment.

For example, a $300,000 75/15/10 loan would break down like this:

Main loan (75%): $225,000
Second loan (15%): $45,000
Down payment (10%): $30,000

Comparing Loan Structures & Uses

1. 80/10/10 Piggyback Loan

Structure:

80% primary loan
10% HELOC
10% down payment

Typical use: Commonly used to avoid PMI and stay under jumbo loan limits

2. 75/15/10 Piggyback Loan

Structure:

75% primary loan
15% HELOC
10% down payment

Typical use: Commonly used when purchasing a condo to avoid higher mortgage rates

The Potential Benefits and Disadvantages of a Piggyback Mortgage

A piggyback mortgage may help homebuyers avoid monthly private mortgage insurance payments and reduce their down payment. But that’s not to say an 80/10/10 loan doesn’t come with its own potentially negative costs.

There are pros and cons of piggyback mortgages to be aware of before deciding on a mortgage type.

Piggyback Mortgage Benefits

Allows for retention of liquid assets. Some lenders request a down payment of 20% of the home’s purchase price. With the average American home price at nearly $303,288, this can be a difficult sum of money to save. A piggyback mortgage may help homebuyers secure their real estate dreams with less cash.
Possibly no PMI required. In what may be the largest motivator in securing a piggyback mortgage, homebuyers may not be required to pay PMI, or private mortgage insurance, when taking out two loans. PMI is required until 20% of a home’s value is paid, either with a down payment or by paying down the loan’s principal over the life of the loan. PMI payments can add a substantial amount to a monthly payment and, just like interest, it’s money that won’t be recouped by the homeowner when it’s time to sell. With an 80/10/10 loan, both loans meet the requirements to forgo PMI.
Potential tax deductions. Purchasing a home provides homeowners with a list of potential tax deductions. Not only is there potential for the interest on the main mortgage loan to be tax deductible, but the interest on a qualified second mortgage may also be deductible.

Potential Downsides of Piggyback Mortgages

Not everyone qualifies. Piggyback mortgages can be risky for lenders. Without PMI, there is an increased risk of financial loss. This is why they’re typically only granted to applicants with superb credit. Even if it’s the best option, there’s no guarantee that a lender will agree to a piggyback loan scenario.
Additional closing costs and fees. One major downfall of a piggyback loan is that there are always two loans involved. This means a homebuyer will have to pay closing costs and fees on two loans at closing. While the down payment may be smaller, the additional expenses might outweigh the initial savings.
Savings could end up being minimal or lost. Before deciding on a piggyback loan arrangement, a homebuyer may want to estimate the potential savings. While this type of loan has the potential to save money in the beginning, homeowners could end up paying more as the years and payments go on, especially because second mortgages tend to have higher interest rates.

To quickly make an assessment, make sure the monthly payment of the second mortgage is less than the applicable PMI would have been on a different type of loan.

Pros of Piggyback Loans

Secure a home purchase with less cash
Possible elimination of PMI requirements
Could qualify for additional tax deductions

Cons of Piggyback Loans

Only applicants with excellent credit may qualify
Extra closing costs and fees may apply
A second mortgage could cost more money over the entire loan term

Qualifying for a Piggyback Mortgage

It’s essential to keep in mind that you’re applying for two mortgages simultaneously when you apply for a piggyback home loan. While every lender may have a different set of requirements to qualify, you usually need to meet the following criteria for approval:

Your debt-to-income (DTI) ratio should not exceed 28%. Lenders look at your DTI ratio — the total of your monthly debt payments divided by your gross monthly income — to ensure you can make your mortgage payments. Therefore, both loan payments and all of your other debt payments shouldn’t equal more than 28% of your income.
Your credit score should be close to excellent. Because you are taking out two separate loans, your risk of default increases. To account for this increase, lenders require a good credit score, usually over 680, to qualify. A higher credit score means you’re more creditworthy and less likely to default on your payments.

Before you apply for a piggyback loan, make sure you understand all of the requirements to qualify.

Refinancing a Piggyback Mortgage

Sometimes homeowners will seek to refinance their mortgage when they have built up enough equity in their home. Refinancing can help homeowners save money on their loans if they receive a lower interest rate or better terms.

But, if you have a piggyback mortgage, refinancing could pose a challenge. It’s often tricky to refinance a piggyback loan because both lenders have to approve. In addition, if your home has dropped in value, your lenders may even be less enticed to approve your refinance.

On the other hand, if you’re taking out a big enough loan to cover both mortgages, it may help your chances of approval.

Is a Piggyback Mortgage a Good Option?

Not sure if a piggyback mortgage is the best option? It may be worth considering in the following scenarios:

If you have minimal down payment resources: Saving up for a down payment can take years, but a piggyback mortgage may mean the homebuyer can sign a contract years sooner than any other type of mortgage.
If you need more space for less cash: Piggyback loans often allow homeowners to buy larger, recently updated or more ideally located homes than with a conventional mortgage loan. This advantage can make for a smart financial move if the home is expected to quickly build equity.
If your credit is a match: It’s traditionally more difficult to qualify for a piggyback loan than other types of mortgages.

For most lenders, a homebuyer will need:

10% down payment
Stable income and employment (proven by tax records)
Debt-to-income ratio of 43% or less

Piggyback Mortgage Alternatives

A piggyback mortgage certainly isn’t the only type offered to hopeful homebuyers. There are other types of mortgage loans homebuyers may also want to consider.

1. Conventional or Fixed-Rate Mortgage

This type of loan typically still requires PMI if the down payment is less than 20% of the home’s purchase price, but it is the most common type of mortgage loan by far. They’re often preferred because of their consistent monthly principal and interest payments.

Conventional loans are available in various terms, though 15 years and 30 years are the most popular.

2. Adjustable-Rate Mortgage

Also known as an ARM, an adjustable rate mortgage may help homebuyers save in interest rates over the life of their loan, but the interest rate will only remain the same for a certain period of time, typically for one year up to just a few years.

After the initial term, rate adjustments reflect changes in the index (a benchmark interest rate) the lender uses and the margin (a number of percentage points) added by the lender.

3. Interest-Only Mortgage

For some homebuyers, an interest-only mortgage can provide a path to homeownership that other types of mortgages might not. During the first five years (some lenders allow up to 10 years), homeowners are only required to pay the interest portion of their monthly payments and put off paying the principal portion until they’re better financially situated.

4. FHA Loan

Guaranteed by the Federal Housing Administration, FHA loans include built-in mortgage insurance, which makes these loans less of a risk to the lender. So while it’s not possible to save on monthly insurance payments, homebuyers may still want to consider this type of loan due to the low down payment requirements.

5. Other Options to Consider

Some other alternatives to a piggyback mortgage might include:

Speaking to a lender about PMI-free options
Quickly paying down a loan balance until 20% of a home’s value is paid off and PMI is no longer required
Refinancing (if a home’s value has significantly increased) and allowing the loan to fall under the percentage requirements for PMI
Saving for a larger down payment and reducing the need for PMI

The Takeaway

Before signing on for a piggyback mortgage, it’s always recommended that a homebuyer fully understand all of their mortgage options. While a second mortgage might be the best option for one homebuyer, it could be the worst option for another. If a piggyback mortgage is selected, understanding its benefits and potential setbacks may help avoid financial surprises down the line.

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