If you’re starting to think about buying a home, coming up with a down payment and closing costs can seem daunting, particularly with today’s rising home prices. If you don’t have enough in your personal piggy bank for these expenses, you might be a candidate for a piggyback loan.
What is a piggyback loan?
A piggyback loan, also called an 80/10/10 or combination mortgage, involves getting two mortgages at the same time: one for 80 percent of the home’s purchase price and another for 10 percent, with the remaining 10 percent covered by your funds for a down payment.
A piggyback loan eliminates the need for you to pay for private mortgage insurance (PMI). Additionally, this arrangement can help navigate around some of the stricter requirements of a jumbo loan: By separating the transaction into two mortgages, you could avoid falling into the “jumbo” category.
There’s one other big reason a piggyback loan can be a help in today’s market: If you’re trying to sell your current home while buying another one, you can take out a home equity loan or a home equity line of credit (HELOC) on your current home to cover part of the down payment on the new one. Assuming you can sell your existing property, you’ll be able to use the proceeds to pay off the loan.
How does a piggyback loan work?
In an 80/10/10 setup, the first mortgage is for 80 percent of the property’s value, and the second — the piggy on the back, so to speak — is for 10 percent. Then, as the borrower, you’ll need to make a 10 percent down payment.
Lenders also sometimes offer an 80/15/5 loan, says Greg McBride, CFA, chief financial analyst at Bankrate, which shrinks your down payment obligation to just 5 percent.
Types of piggyback loans
Piggyback loans come in a few different flavors:
- Taking out a second mortgage: In a traditional piggyback loan, you’ll have two mortgages. That means two sets of closing costs with two different sets of terms. It might even mean using two different lenders.
- Home equity loan: If you’re currently living in a home that you’ve paid off (or paid down substantially with your mortgage), you can take out a home equity loan, a lump sum of cash that you can put on the back of a mortgage for 80 percent of the purchase price.
- HELOC: A HELOC is similar to a home equity loan, except that the rate on a HELOC is variable, so your monthly payments can change, and you’ll draw down funds rather than take out a big chunk at one time.
Pros and cons of piggyback loans
- You can eliminate mortgage insurance premiums. The main upside to a piggyback loan is the chance to ditch private mortgage insurance. For a conventional loan borrower with 3.5 percent down, the average annual PMI premium ranges from 0.58 percent to 1.86 percent of the loan principal, depending on credit score, according to Urban Institute reporting. With a piggyback loan, you can get a reprieve from those insurance payments without having to look for a smaller and cheaper home.
- You can avoid jumbo loan requirements. Jumbo loans typically come with the need for a higher credit score, a higher down payment and plenty of cash reserves. If the piggyback arrangement helps keep the loan within conforming limits, those requirements will not apply.
- You can make a lower down payment. While the most common down payment of a piggyback loan is 10 percent of the purchase price, you might be able to find an 80/15/5 setup, meaning your down payment would be just 5 percent of the cost.
- Your payments might change. A piggyback loan still costs money. The second loan typically has a higher interest rate, and it’s variable, McBride says, so if the interest rate goes up, you’ll pay more.
- You still have two sets of closing costs. If you take out a traditional second mortgage, you’ll have two bills for closing. That eats into any potential savings from avoiding PMI.
- You might have trouble if you need to refinance. If your loans are through two different lenders, refinancing down the road might not be a simple process.
Why qualifying for a piggyback mortgage can be more difficult
Piggyback loans might help you get around some of the requirements of a jumbo loan, but these are by no means easy approvals, either. You still need an excellent credit score, and the need to borrow more money can raise eyebrows from lenders. Expect to have your personal finances scrutinized to verify that you can indeed pay back both loans. If you’re thinking about trying to get a piggyback loan, it’s wise to reduce your debt-to-income (DTI) ratio as much as possible before applying.
Alternatives to a piggyback loan
Piggyback loans were common before a lot of low-down payment mortgage programs became mainstream, McBride says. If you’re stressing over that 20 percent down payment, there are a number of first-time homebuyer loans and grants that can help you move into a home for less upfront money without the added layer of a piggyback loan:
- FHA loan – Backed by the Federal Housing Administration, an FHA loan allows you to get away with as little as 3.5 percent down on a home purchase. You can also qualify for this loan with subpar credit. The program requires a minimum credit score of 580 for the 3.5 percent down payment. If your credit score is between 500 and 579, you’ll need to put down 10 percent.
- Conventional 97 – Fannie Mae and Freddie Mac, the two government-sponsored enterprises, help make mortgages available with as little as 3 percent down.
- VA loan – If you’ve served or are active in the military, you’re eligible for a loan backed by the U.S. Department of Veterans Affairs, and you don’t have to put any money down to get it.
With a low-down payment program, you’ll be able to write a smaller check, but depending on your lender, also might be required to expand your home-buying knowledge. For example, Bank of America’s low-down payment loan program stipulates that borrowers might need to complete homebuyer education courses. However, investing a few hours of your time is a small price to pay to be able to afford your own place.
You might be pondering delaying a home purchase until you can make a more sizable down payment, but McBride points out that the waiting game can be a losing formula.
“Home prices have been rising faster than people could save, so the idea of making the 20 percent down payment is a moving target,” McBride says. “Especially for a first property, it’s entirely plausible to make a smaller down payment to get into that starter home. Then, after a few years, when you trade up to a more permanent home, you have enough equity that it becomes your 20 percent down payment.”