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What’s a Piggyback Mortgage?

Written by Nickel - 15 Comments

When buying a house, lenders typically require that you either make a 20% down payment, or carry private mortgage insurance (PMI). Obviously, you don’t want to incur unnecessary expenses, such as PMI, but it’s not always possible to come up with the cash for a 20% down payment. If you can’t arrange for a gift from a family member to make up the shortfall, but are still determined to avoid PMI, then you might want to consider taking on a piggyback mortgage.

In general terms, this entails making a smaller down payment (say 10% or even 5%) and then borrowing against the downpayment to make up the difference (an additional 10% or 15%) to get to the full 20% mark. This then allows you to take out a standard 80% first mortgage, and avoid the PMI entirely. In other words, you might have an 80% first mortgage, a 10% second (piggyback) mortgage, and 10% down payment (in the case of an 80/10/10 mortgage), or an 80% first mortgage, a 15% second (piggyback) mortgage, and a 5% down payment (in the case of an 80/15/5 mortgage).

A couple of things… Yes, you’ll be responsible for two mortgage payments (the 80% first mortgage as well as the smaller second mortgage). And because the second mortgage is subordinate to the first (i.e., the lender backing the first mortgage is first in line when it comes to collecting what’s owed them in the case of a default), the rate is typically somewhat higher. But there are some advantages to doing it this way. First and foremost, some (initially small) fraction of the payment on your second mortgage will go toward equity (unless you’re doing an interest only loan), whereas PMI payments just go out the window. Second, the interest payments on your second mortgage payment (like those on your first mortgage) are tax deductible, whereas PMI is not.

As far as second mortgage options go, you can take either a standard home equity loan, wherein you agree to pay it back over a fixed period of time, or you can use a home equity line of credit (HELOC), which provides you with the flexibility of putting the money in and taking it back at more or less at will. In our case, we started with a 80/10/10 with a standard home equity loan that was amortized over thirty years, but due in ten years (i.e., we would’ve either had to make a balloon payment or refinance at the ten year mark). When we later refinanced our first mortgage to get a more favorable rate, we also refinanced the second mortgage into a HELOC from our local bank. The interest rate on a HELOC is pegged to the prime rate (+/- a small amount) so it floats. However, the rates were so good at the time that we came out way ahead by floating this portion until we killed it off.

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Published on April 19th, 2006
Modified on September 10th, 2006 - 15 Comments
Filed under: Mortgages

About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!

15 Responses to “What’s a Piggyback Mortgage?”

1
Blaine Moore Says:
April 19th, 2006 at 7:59 am
One thing to note is that your piggyback mortgage tends to amortize faster, as well. We did an 80/4/16 loan, and the 4% mortgage is over 20 years instead of 30. This means you build equity faster.

Also, when you take out a loan like this, you still have private mortgage insurance. The difference is that your lender is paying for it, and you are not. That is another reason that the second mortgage tends to have a much higher rate.
2
Lisa Says:
April 19th, 2006 at 8:48 am
Another note, using a HELOC will have an adjustable rate, but minimum payment is interest only. So, the good news is that if you have a bad month, you can squeak by only paying the interest. The other good news is that you have a line of credit that you can continue to borrow from should the need arise (not good for those of us trying to get out of debt). The bad news is, those interest rates are on the rise and you need to consciously make “greater than interest only” payments if you want to get ahead.

The HEL provides some flexibility in whether you go adjustable or fixed rate, but you will be forced to pay some of the principal every month with “fixed payments”.
3
Dan Says:
April 19th, 2006 at 9:02 am
I am very much against PMI. I think it’s a terrible waste of money and I’d much rather put that money to work for me. So we got an 80/10/10, with a HELOC providing that last 10%. We had every intention of paying it off very quickly, but my wife had just gotten back into the working world after getting another degree, so we couldn’t afford a big down payment. Plus it allowed us a little flexibility to make those “first home” purchases like some respectable furniture and appliances.

Then we went on a debt rampage and paid off a car, a school loan, and set our sights on the HELOC. In two months we’ll have that all paid off too, and it’s only been two years.

It’s highly unlikely we’ll ever be in the position of paying less than 20% down on a house ever again. But if we were, I’d do this all over again. Might as well put that money toward our own equity and not some useless thing like PMI.
4
FMF Says:
April 19th, 2006 at 10:58 am
I saved the 20% needed, put it down on the house, and added extra mortgage payments. Seven years later, no debt.
5
Brian Says:
April 19th, 2006 at 11:14 am
We took the 80/10/10 route to purchase our home, but if we had to do it all over again we would have waited until we had the full 20% to put down.
6
Amanda Says:
April 19th, 2006 at 11:16 am
I definately think waiting to save up the money is the best route. Buying a house you can’t afford is just too risky…
7
try2bekuber Says:
April 19th, 2006 at 11:42 am
Another option to avoid PMI would be to roll in the PMI amount into the money that you get financed. While I am not sure if this has a downside, I hate to pay the higher interest on a piggy back loan, which is around 3% over prime.
8
Dan Says:
April 19th, 2006 at 12:02 pm
Let me clarify that in our case, it wasn’t that we were stretching buy a house we couldn’t afford. My wife had been back in school (and out of the full time workforce) for a couple of years getting another degree, and so when she finished and we were searching for a house, monthly payments were not the issue because I crunched the numbers in advance and made sure our purchase would be well within our budget. The piggyback HELOC was just to help us put enough money down. We knew we’d be aggressive in paying down the HELOC, and two years later we’re just two payments away from wiping it out.

I agree that a piggyback mortgage is not a good idea if your sole purpose is to stretch to buy a bigger house. In an ideal world, saving 20% is the way to go.

But when you’re itching to get out of an apartment and are on pretty good financial footing but just need that last little bit to get you over the hump, a piggyback mortgage is a great alternative to PMI.
9
meg Says:
April 19th, 2006 at 9:07 pm
Here’s a thought (and it has been hashed over thoroughly at Fat Wallet) but why didn’t you do a 0% BT instead of the 2nd mortgage. I ended up getting a much needed 30K to put down into our mortgage such that we met the downpayment percent required. Now we don’t have to pay PMI and we get 30K interest free for a year. (we will pay back the 30 K after the year or two or three ends by selling some CDs which are not up for another year.
10
nickel Says:
April 19th, 2006 at 10:21 pm
While it may end up working out, I’m not crazy about the idea of maxing out my credit cards while I’m in the process of applying for a mortgage. Actually, I’ve never really gotten into the 0% balance transfer game. I realize that I’m probably leaving money on the table, but it’s never really been worth it to me.
11
Jerry Kindall Says:
April 21st, 2006 at 1:41 pm
The balance transfer game is great fun, but it doesn’t start to be actually profitable until you’re significantly leveraged. Right now I have just under $10,000 in 0% loans (all of it in a savings account earning 4.5% interest). I’ll make over $400 off my credit this year, which I’d imagine would be right on the edge of being “worth it” for most people. But frankly, I like getting free money (and stuff) regardless of how much it is, that’s just how I am. I’ve already collected $100 this year just for opening bank accounts (last year I made $75 at this).
12
Boris Says:
April 26th, 2007 at 1:20 pm
What happens when you pay more than the regular monthly payment for a piggyback mortgage? Does it reduce future monthly payments or just reduce the principal out of the back end?

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