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Should you jump on a piggyback mortgage?

Home buyers who can't afford a 20-percent down payment usually have to pay private mortgage insurance, or PMI. This protects the lender in case the buyer defaults on the mortgage, although the homeowner pays the monthly premium.

Getting rid of PMI isn't easy or automatic -- but some homeowners are avoiding it altogether. A small but growing number of buyers are choosing an alternative to PMI: piggyback mortgages.

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Named because a second mortgage is "piggybacked" onto the original mortgage loan, it can be a less expensive way to go. However, not all homeowners will qualify for piggyback loans, and the savings aren't assured.

"A piggyback mortgage is a second mortgage that closes simultaneously with the first," explains Chris Larson, chief executive officer with E-Loan, an online provider of consumer loans based in Dublin, Calif. Often, the first loan is for 80 percent of the value of the home, and the second is for 10 percent. The buyer has to come up with the remaining as a down payment. (Another name for piggybacks is 80-10-10s.) A few lenders also allow second loans up to 15 percent or even 20 percent of the value of the home.

The interest rate on the second loan is often one to two percentage points higher than the first because fewer lenders are willing to carry the loans, and in the event of default, second mortgages gets paid back second, making them riskier to lenders.

While statistics on the growth in use of piggyback mortgages are difficult to come by, industry experts say they have seen a noticeable increase in their use.

In 2000, for instance, LaSalle Bank N.A. did $80 million in piggyback mortgage loans; that number jumped to $300 million last year, says Joseph Clements, vice president with the Chicago-based firm.

Why they're popular
Several factors are driving the growth. Not surprisingly, many home buyers want to avoid private mortgage insurance. While a piggyback mortgage means the home buyer has two loans to pay off, the cost may still be cheaper than paying for PMI. In part, this is because the interest on the piggyback mortgage is tax-deductible for most home buyers, while PMI isn't deductible.

Home buyers who are looking at larger mortgages may use piggyback mortgages to keep their primary mortgage below the conforming limits set annually by Fannie Mae and Freddie Mac, the agencies that dominate the secondary market in mortgages. Currently, 30-year fixed mortgages on single family homes that exceed $300,700 are considered "jumbo" mortgages, and carry an interest rate that's about .05 percent higher.

Finally, piggyback mortgages can offer home buyers some flexibility, says Nancy Flint-Budde, a certified financial planner in Clifton Park, N.Y.

For instance, some lenders structure the second loan as a home equity line of credit. Homeowners who pay off the line of credit can continue to draw down on it and use the funds for other purposes. Or, home buyers who expect to receive a large amount of money, such as a bonus, can use the funds to pay off the second mortgage. That course requires discipline, however.

"If they use the cash for other purposes, they can get into trouble," says Robert Mecca, CFP with Robert A. Mecca & Associates in Hoffman Estates, Ill. "They'll still have the balance out there."

Not always the better option
While piggyback mortgages can offer savings, home buyers need to do some hard-core number crunching. The mortgages aren't for everyone, and aren't automatically the low-cost option.

For starters, there's an unknown that can throw the comparisons out of whack: how quickly the home rises in value. If the value of a home remains stable or falls, that lengthens the time a homeowner would have to pay PMI. On the other hand, if the home's value rises, the owner will be able to drop PMI sooner. For homeowners with mortgages that closed after July 29, 1999, lenders are required to cancel PMI when the loan balance falls below 78 percent of the purchase price.

In addition, qualifying for a piggyback mortgage is more difficult than qualifying for a traditional mortgage. Typically, borrowers need a FICO score of about 680 to qualify for the second mortgage, says Larson of E-Loan. For a first mortgage, a FICO score of about 620 usually is adequate. FICO scores -- named for Fair, Isaac & Co., the firm that developed the calculation -- measure individuals' records in using credit.

Lenders usually limit the second loan to $100,000, and will offer piggyback loans only on single-family detached homes, says Larson. The piggyback mortgage usually has to be for a primary residence. In addition, home buyers who are getting an FHA loan need to go with PMI.

Some second loans are structured so that the home buyer makes only interest payments during the course of the loan, with a balloon payment due on the principal after 10 or 15 years. At that point, the homeowner either has to pay off the loan or refinance. A word of warning: homeowners who refinance might find that rates have gone up. In addition, they won't have built up much equity in their home.

Home buyers who can put down close to 20 percent may find that it makes sense to go with PMI. That's because the premiums usually decline as the mortgage gets closer to 80 percent of the value of the house, says Flint-Budde.

That's it -- no more loans
Another consideration: Taking out both a first and second loan will make it very difficult, if not impossible, for home buyers to take out additional loans using their homes as equity. Few lenders are willing to stand third in line.

A final alternative to PMI is available, though most experts advise against it: lender-paid mortgage insurance, or LPMI. Here, the cost of the PMI is rolled into the mortgage itself. They're seldom advisable because payments are amortized over the entire life of the loan.

Ultimately, determining which is more appropriate -- paying private mortgage insurance or going with a piggyback loan -- requires seriously analyzing monthly payments and any fees for all alternatives, for at least several years into the future. "You want to really sit down and do a side-by-side comparison," says Clements.

Karen M. Kroll is a freelance writer based in Minnesota

-- Posted: July 25, 2002




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