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Pros And Cons Of Piggyback Mortgage Loans
A piggyback mortgage is a term used to describe the simultaneous financing of a property purchase with two home loans.
This financing strategy has two main benefits which a buyer wishes to enjoy.
- A low down payment requirement
- Avoid private mortgage insurance (PMI)
The first mortgage usually makes up the bulk of the required financing, while the second will be a much smaller amount.
This implies that the first lender would place a first priority lien on the property, while the second lender would have a lower priority lien.
The remaining portion of the required funds for closing will be paid by the buyer as cash down payment.
Types of piggy back loans
Some of the common types of piggy back mortgages are:
- 80 10 10
- 80 5 15
- 80 15 5
In the first listed example, the first number refers to the first mortgage financing 80% of the transaction price, the second figure represents the second mortgage financing 10%, with the remaining 10% funded by down payment.
Types of piggy back home loans are always represented by 3 numbers with the first being the first mortgage, the second being second loan, and the third number being the down payment.
This implies that since they are separate loans, that they can have different interest rates, points, and terms, etc.
In the event that both loans are funded by the same lender, there is a higher chance of them having the same terms.
However to reduce exposure to risks, lenders these days often don’t finance the second loan and prefer to recommend their smaller lending partners to take it on.
This does not mean that a borrower would source for both lenders themselves.
This is because a lender offering to piggyback would only want to work with another lender which they are comfortable with.
So the choice of the second lender would usually come down to the options available on their panel, or the decision would be made for the borrower.
Drawbacks of piggyback mortgages
The first drawback that most people should implicitly realize is that a borrower would now be managing two separate loans instead of one.
This can be more tedious to manage.
In addition, late payments are going to cause a double delinquency on the credit record.
The second disadvantage is that it can be a huge hassle to obtain approval.
Keeping in mind that the lenders would be taking on considerable risks with such highly leverages borrowers, one can expect having to submit a flurry of documentation for underwriting and approval… twice.
While not explicitly stated, a high credit score is a must.
A third pitfall is that because of the complexity of such loan arrangements, it can be difficult to refinance.
On top of that, they would also inevitably demand a subordination of the second mortgage lender if they were to only refinance the first mortgage.
Another downside of piggybacks is that the second loan would almost always be an adjustable rate mortgage.
This means that market movements would affect indices, which would affect the interest on the loan.
Seldom will the second be offered at a fixed mortgage rate.
Lastly, a borrower can forget about streamline refinancing.
Should you ride on piggyback mortgage loans?
The concept of piggy back mortgages such as an 80/10/10 is so that they can make a small down payment.
This also enables them to sidestep private mortgage insurance which can be expensive.
However, if mortgage insurance premiums are not something a homebuyer wants to avoid, FHA mortgages can actually allow a borrower to pay as little as 3.5% down payment.
In this case, FHA have their own insurance programs called MIP with annual premiums that costs 0.80% of the loan amount.
There are other variations of how MIP is charged on the borrower.
Then there are upfront fees to pay for FHA loans too.
So if we compare the numbers, going with piggy backs might be more worthwhile unless you are going for 20% down payment.
In which case, FHA would be a more attractive proposition.
But if one is going for 20% down, then there is every chance that a better loan is available somewhere in the market. Something a broker might make short work of.
So if piggy back loans is something that makes sense to you, and you are able to obtain approval from the lenders, they are probably a good way to move forward with in terms of financing your home purchase.