Piggyback Loan: What It Is + Alternatives

When you’re looking for the perfect loan for your homeownership aspirations, you might be interested in so-called piggyback loans. Piggyback loans could be great home loan instruments, depending on your circumstances and goals.

However, it’s also crucial to know the possible downsides and alternatives to piggyback loans so you fully understand your options.

What Is a Piggyback Loan?

The best way to understand piggyback loans is to understand second mortgages. In a nutshell, a second mortgage is a loan enshrined with rights subordinate to an initial or primary mortgage. For instance, if you have two mortgages on your property and you want to sell that home, the first mortgage gets paid off before the second mortgage gets paid off.

Many homeowners use second mortgages to pay off loans and credit card debts or resolve other personal finance issues. Piggyback loans, which can also be called 80/10/10 loans, are a bit different.

With a piggyback loan, the borrower takes out a first and second mortgage loan simultaneously. A borrower might take out a piggyback loan so they don’t have to pay private mortgage insurance (PMI) premiums or high interest rates — or so they can purchase a new home without taking out a jumbo loan.

The first loan in a piggyback loan arrangement will cover 80% of the home’s purchase price covered by a 30-year fixed-rate mortgage without PMI. The second mortgage, the piggyback part of the loan, covers 10% of the home price as a home equity loan, home equity line of credit (HELOC), or similar instrument. Then, the homeowner pays the last 10% of the home price as a cash down payment.

Homebuyers must be aware that piggyback loans often have higher interest rates compared to a standard mortgage loan. The rate is contingent on the loan amount, the home’s value, and mortgage rates in the surrounding market. These second loans may not be the best for first-time homebuyers who are looking for a conventional mortgage.

Piggyback Loan Requirements

Though piggyback loans can be attractive, they aren’t available to everyone. You have to qualify for these loan instruments. Plus, the fact that piggyback loans let you finance a huge portion of your home could make eligibility more difficult than you expect.

To qualify for a piggyback mortgage loan, you must usually:

• Have a strong credit score of 700 or higher. You may be able to get away with a credit score of 680 or so, depending on your mortgage lender.
• Have a low debt-to-income ratio (DTI) ratio. Generally, your debt-to-income ratio needs to be 36% or less when accounting for the repayments of both loans in a piggyback loan.

What Are the Benefits of a Piggyback Loan?

Piggyback mortgage loans are popular mortgage instruments among aspiring homeowners because of their many benefits, including:

• You avoid private mortgage insurance premiums. PMI is usually included with first-time home mortgages to prevent lenders from defaulting borrowers. It’s cheaper for a homeowner to get two mortgages at the same time since the borrower doesn’t have to pay this monthly fee. Normally, you have to build up 20% equity or more in your home before you can drop PMI.
• You also benefit from low down payments. Normally, you need a down payment of 20% to 30% to qualify for a standard mortgage. With a piggyback loan, you only have to make a down payment of 10%. Some piggyback loans even let you do a 5% down payment through so-called 80/15/5 loans.
• Piggyback loans are highly convenient. Because you close your piggyback mortgage at the same time as your primary mortgage, you don't have to pay two sets of closing costs or handle the scheduling nightmare of arranging two loan meetings with various loan officers.
• With the extra money you save from a piggyback loan, you can make aggressive payments toward your primary mortgage, put the money in your 401(k), or pay off high-interest credit card debt.

Are There Downsides to a Piggyback Loan?

As a potential homeowner, you should also recognize the risks and cons of piggyback loans:

• Piggyback loans (the second mortgages specifically) may have higher-than-average interest rates. That’s because the piggyback loan or secondary mortgage is tied to short-term interest rates, and the cost of these rates could outweigh how much you would pay with normal PMI fees over several months or years. You can sometimes find a piggyback loan with a lower interest rate.
• The second mortgage in a piggyback loan setup has a shorter loan term. This means you have higher monthly mortgage payments toward the principal.
• You can usually only take out a piggyback loan for primary residences. These aren’t good for real estate investors or those who want to become landlords to acquire passive income.
• The second mortgages in piggyback loans usually don’t go any higher than $100,000. This may limit your loan options in some circumstances.
• Some lenders simply don’t offer piggyback loans due to the riskier nature and profitability of the product. In this case, you may have to work with lenders who you don’t know or have a long-term relationship with.

What Are Some Alternatives to a Piggyback Loan?

Given the potential disadvantages of a piggyback loan, you may want to look into alternatives. You may try qualifying for other types of loans if you want to purchase a property.

FHA loans are backed by the Federal Housing Administration. As government-backed loans, they are secure, so you can sometimes purchase a house with just a 3.5% down payment. Even better, many FHA loans are available for those with low-to-bad credit. You generally need a minimum credit score of 580.

Or, you can look for a VA loan if you are a veteran or actively serving the military. These are backed by the U.S. Department of Veterans Affairs. Unlike FHA loans, you don’t always need a down payment to qualify for a VA loan.

Conventional loans from Fannie Mae and Freddie Mac are other alternatives. These are government-sponsored lenders, so their mortgages are occasionally available for down payments as low as 3%. However, you generally need a good credit score to qualify.

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Sources:

What is private mortgage insurance? | Consumer Financial Protection Bureau

Loans | HUD.gov / U.S. Department of Housing and Urban Development (HUD)

What Is a Second Mortgage? | Experian

What Is a Home Equity Line of Credit, or HELOC? | NerdWallet