Piggyback Mortgages: You Have Questions, We Have Answers

As you try to determine the best home loan for your needs/goal - with options available that range from basic fixed-rate mortgage products to an interest-only mortgage - consider a piggyback loan.

We’ll review a few of the most common questions surrounding this resource below.

Q: What is a piggyback mortgage?
A piggyback mortgage is actually a package of two loans, one added on top of the other. For residential properties, that usually means a first mortgage which covers 80% of the value of the property, plus a second lien which covers 10%, 15% or even the whole remaining 20% of the value of the home.

The second loan - which can be either fixed or an adjustable-rate mortgage - is “piggybacked” on top of the first loan.

Q: What’s the point? Why not simply take one mortgage for 90%, 95% or even 100% of the value of the property?
A little (short and simplified) mortgage history may be helpful here.

In the past, if you had less than 20% of your own money to put up, financing probably wasn’t available to you. Naturally, the less of your money you put toward the purchase of your home, the more risk the lender needs to shoulder.

Mortgages with small down payments represent a greater risk to the lender/investor because a borrower with a lesser interest in the property may simply walk away (default) in the event of severe financial trouble.

Mortgage insurance, or MI, helps to indemnify the lender/investor by covering a portion of the value of the property. If the borrower defaults, the MI will usually cover the costs of foreclosing on and repairing the property, as well as the costs for selling it.

Typically, if the lender must accept more risk, you’ll pay a higher rate, higher fees, or both - a sort of “risk premium.” Back in the day, lenders were not eager to make loans in excess of an 80% Loan-to-Value ratio, since they couldn’t easily be sold to the secondary market; essentially, the lender would have to keep your loan, and all of the risk of delinquency or default, for the entire term.

Q: Which is better - A piggyback, or a traditional loan with MI?
Either method has both advantages and drawbacks. For example, MI may be cancelable after a fairly short period of time through no effort on your part, aside from making your regular monthly payments. That is, if the value of your home has risen sharply, you may be able to cancel MI in just two years.

You have no such option for the second lien arrangement, though; you signed on for a given number of payments to retire the lien, and that cannot be changed without a slug of cash to pay off the loan (or a mortgage refinancing).

Of course, if you’re not diligent about making your payments on time, your mortgage lender can refuse to cancel your MI. You could always refinance, of course, although rates may not favor you. On the other hand, even if you’re late occasionally with payments on your second home loan, it will still have a fixed termination date and a known cost.

As we mentioned above, there can be tax benefits for a second lien versus MI situation, at least on a comparable basis, but only if you itemize on your tax return.