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Mortgage

Are Piggyback Loans a Good Idea?

Piggyback loans, also called combination mortgages or 80-10-10 loans, are home loans consisting of two separate mortgages. With a piggyback mortgage, you can buy a property with just a 10% down payment but avoid paying the mortgage insurance that's required when a down payment of less than 20% is made on a conventional mortgage.

Piggyback mortgages are nothing new, but they declined in popularity after the mortgage lending crisis of the late 2000s. Lately, they are making a comeback as housing markets gain strength.

What Is a Piggyback Loan?

With a piggyback mortgage, you obtain a conventional mortgage—known as the primary loan—for 80% of the home value. Then you secure a secondary loan from a different lender that "piggybacks" on the first to cover another 10% of the home price. The secondary loan is typically a home equity loan or a home equity line of credit (HELOC)—both forms of credit that use the house as collateral.

You're still borrowing a total of 90% of the home's purchase price, but reducing the size of your primary mortgage loan has certain benefits.

When Is a Piggyback Loan Necessary?

There are two strategic reasons borrowers typically seek piggyback loans: to avoid the cost of private mortgage insurance (PMI), and to skirt the need for a costly "jumbo" mortgage on a property priced significantly higher than other homes in its community. Here's the lowdown on both.

PMI Avoidance

A borrower who makes a down payment of less than 20% of the home's purchase price typically must pay for PMI—at a cost ranging from 0.5% to 2% of the home's value—to shield the lender from loss in case the borrower defaults on the loan. PMI can be removed once principal payments bring the borrower's equity up to 20% of the home's market value, but that can take 12 years or so on a 30 year mortgage with 10% down—and can add up to thousands of dollars.

A 10% piggyback loan in addition to a 10% down payment can bring a borrower's down payment up to 20% and nix the PMI requirement without the need for more savings. Interest charges will apply to the secondary loan as well, of course, and at a higher rate than the one on the primary loan. But the monthly payment amount will be considerably lower than for the primary loan, and you can save money if you manage to pay off the piggyback loan relatively quickly. (If it's a home equity installment loan, make sure there's no prepayment penalty that will cost you extra if you pay it off ahead of time.)

If the secondary loan is a HELOC, total cost can be less predictable. HELOCs often carry adjustable interest rates that can increase annually. With many HELOCs, you'll make interest-only payments for the first 10 years, but some let you pay the principal balance as well. As with a credit card, you can make payments of any amount each month, and pay off the debt as quickly (or as slowly) as you choose. If you can pay the balance in full relatively quickly, you can still see savings compared with what you'd spend on PMI.

To get an idea of the opportunity for PMI savings from a piggyback loan, let's say your credit score is 700 and you're buying a $300,000 house with a 10% ($30,000) down payment:

  • With a conventional 30-year mortgage, that'd mean financing $270,000 and purchasing PMI. Using the Experian Mortgage Calculator (and ignoring taxes and homeowners insurance), a loan with a 3% interest rate and a 0.5% PMI cost would mean a monthly payment of $1,251.33.
  • With a piggyback mortgage, a primary 30-year loan for $240,000 at that same 3% interest rate, plus a $30,000 secondary 15-year loan at a rate of 3.5%, would yield an initial monthly payment of $1226.31.

That difference might not seem great, but in the time it'd take to qualify for PMI removal on the conventional loan (about nine and a half years), the piggyback mortgage could save you nearly $3,000.

Jumbo Loan Avoidance

A jumbo loan is a mortgage for an amount that exceeds the "conforming loan limit" that makes mortgages eligible for purchase by Fannie Mae and Freddie Mac, the government-sponsored enterprises that ultimately buy and administer most single-family home loans in the U.S. For most of the U.S. in 2020, that means a loan on any house priced above $510,400.

Because lenders cannot sell jumbo loans to Fannie Mae or Freddie Mac, they typically impose steeper approval requirements on them, including higher credit score requirements and lower debt-to-income (DTI) ratios than they seek for conforming loans. Lenders also may require down payments as high as 30% on jumbo mortgages.

A piggyback loan can help you skirt jumbo loan requirements if you use the primary loan to finance the first $510,400 of the home price and cover the rest (less your down payment) with a secondary loan.

What Are the Drawbacks of Getting a Piggyback Mortgage?

While piggyback mortgages are once again gaining popularity, they are by no means easy to get. You'll likely need a credit score in the very good (740-799) or exceptional (800-850) FICO ranges to qualify.

In addition, you'll have to apply and qualify for both loans separately. (If you tell your primary lender you want a piggyback loan, they can likely recommend lenders that will be favorably disposed to issue a secondary loan, but you'll still have to meet both lenders' requirements).

A separate closing will be required for each loan, with all the expenses that entails, potentially including origination fees and the costs of home appraisals, legal fees and so on. It's important to map out the total costs of both loans (the Experian Mortgage Calculator can help) when determining whether a piggyback loan saves you money compared with a jumbo loan or a traditional mortgage that requires PMI.

If your circumstances change and you can't pay back the secondary loan as quickly as you'd hoped, you may end up spending more over time on a piggyback loan than you would on a traditional mortgage plus PMI. And if you're unable to keep up with the payments on either loan, you could lose the house, since both lenders can claim the property as collateral against what you owe them.

If you decide to refinance the house at some point in the future, having two loans on the property could complicate your ability to qualify for a new loan. You may have to pay off the secondary loan in full before you can arrange refinancing.

How Do You Qualify for a Piggyback Loan?

Every lender has its own specific requirements, and requirements for different loan types may vary, but typical requirements for a piggyback loan include:

  • A minimum credit score of about 700, with greater odds of success with scores of 740 or better.
  • A debt-to-income (DTI) ratio of no more than 43%, after payments for both the primary and secondary mortgage loans are taken into consideration. This means your monthly debt payments, including both loans, will have to be less than 43% of your gross monthly income—a requirement comparable to those for many traditional mortgages.

What Credit Score Is Needed for a Piggyback Mortgage Loan?

While mortgages loans are available to borrowers with a fairly wide array of credit scores, piggyback mortgages are more exclusive. Taking out two loans against a house on Day One is inherently more risky than taking out a single loan, and lenders tend to reserve the option for borrowers with high credit scores that reflect strong histories of successful debt management.

Some lenders might approve a piggyback loan application if your credit score is in the high 600s, but you're likelier to qualify with a credit score of at least 700, and a score closer to 740 would be likelier to win approval

If you're interested in seeking a piggyback loan and feel a better credit score would help your approval odds, you can take steps today that can bring up your credit score within the next six to 12 months. Put your best foot forward and a piggyback loan could save you money on a new home.