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If you’re looking for a home but it’s out of your price range—particularly in markets where housing prices are skyrocketing—using a piggyback loan can help ease upfront costs.
A piggyback loan is actually a second loan after the first mortgage used to finance one property. It’s typically used to lower initial mortgage costs like a down payment or private mortgage insurance, which many lenders require on the first mortgage.
Most lenders prefer you have at least 20% of the home’s value saved for a down payment. However, it’s not always possible to have that much in cash (without hurting your savings), especially if home values are rapidly rising.
There are some programs that allow borrowers to put a smaller amount of money down, such as Federal Housing Administration (FHA) or Veteran Affairs (VA) loans, but they come with certain requirements (income, location, etc.) that you must meet. Plus, you may be required to pay additional fees, making a piggyback loan a more attractive alternative
Here’s what you should know about piggyback loans for home financing.
How a Piggyback Loan Works
Here’s how a piggyback loan works: You take out a mortgage for the standard 80% of the home’s purchase price. However, instead of paying the other 20% in cash for a down payment, you take out a second loan—typically at 10%—and then put the remaining 10% down with cash.
For example, say you want to buy a home for $200,000 and you only have $20,000 saved. If you use the piggyback loan strategy, you would take out a mortgage for $160,000 (80%). Then, you would take out a piggyback loan for another $20,000 (10%). Finally, you’d pay the remaining $20,000 (10%) as the down payment.
With this strategy, you take out both loans at the same time. The second smaller loan, which is usually a home equity loan or line of credit (HELOC) with a 10-year draw period, piggybacks on the first one to meet your total borrowing needs.
However, you don’t necessarily have to borrow both loans from the same lender. Let your primary mortgage lender know you plan to use a piggyback loan, and they will refer you to a second lender that can provide the additional financing.
Types of Piggyback Loans
Though the scenario above is the most common piggyback loan structure, it’s not the only way to divvy up the funds. Here’s a closer look at the two most common options.
Piggyback loans are also referred to as 80/10/10 loans since that’s the most popular way to split the funds percentage-wise. The first number refers to the primary mortgage amount (80%), while the second number represents the piggyback loan amount (10%). The last number represents the down payment amount (10%).
Another common way to split up a piggyback loan is 75/15/10. This means 75% of the home purchase price goes to the first mortgage, 15% to the secondary loan and a 10% down payment. This version is often used when financing a condo since mortgage rates for condos are higher when the mortgage’s loan-to-value (LTV) is greater than 75%.
Using the same $200,000 example from above, a piggyback loan with a 75/15/10 structure would look like this:
- Primary mortgage: $150,000 (75%)
- Secondary loan: $30,000 (15%)
- Down payment: $20,000 (10%)
Why Qualifying for a Piggyback Loan May Be Difficult
A piggyback loan might sound the better option in theory, but there are risks, so the lender will expect proof that you can handle the extra debt.
One important thing to keep in mind is that the mortgage lender will look at your debt-to-income (DTI) ratio when qualifying you for the loans. Since you’re essentially taking out two loans for a home, this means you’re taking on more debt, so you will need to have a higher income to cover both.
Your DTI should be no more than 28%, meaning the total monthly cost of both of your loans can’t total more than 28% of your gross monthly income. If you bring home $6,000 in monthly pre-tax income, for instance, you won’t qualify for a piggyback loan that costs more than a combined $1,680 per month.
Additionally, since taking on two separate loans at once is particularly risky, you’ll need good credit to qualify for a piggyback loan. Each lender has different requirements, but the standard is a credit score of at least 680.
Pros & Cons of Piggyback Loans
There are a few reasons why you may or may not opt for a piggyback loan.
- Smaller down payment. If you haven’t saved a full 20% down payment and don’t want to risk getting priced out of your desired home, a piggyback loan can help make your purchase now without waiting to save up.
- Skip PMI. If you take out a conventional loan with less than 20% down, you’re required to pay private mortgage insurance (PMI) until the loan value drops below 80% of the home’s value. However, with a piggyback loan, you avoid the need to pay PMI since none of your loans exceed a loan-to-value ratio (LTV) of 80%.
- Avoid a jumbo mortgage. Another reason to use a piggyback loan is to avoid taking out a jumbo mortgage, which is a loan that exceeds the borrowing limits set by Fannie Mae and Freddie Mac. Jumbo mortgages come with higher rates and stricter eligibility requirements. So if you need to borrow a large amount, splitting it up into two loans can help you avoid these roadblocks.
- Lower interest rates. If you’re buying a condo, using a 75/15/10 piggyback loan can help you avoid the higher rates that typically come with these properties due to a higher LTV.
- A piggyback loan could be more expensive than PMI. Though paying PMI can put a strain on your budget, so can making two mortgage payments. Depending on the amount, the payment on your secondary loan might be higher than what you would pay in PMI.
- Harder to qualify. A piggyback loan requires you to have a low debt load in comparison to your income and good credit, making it tougher to get approved.
- Double the closing costs. Taking out two loans means closing on two loans, and paying closing costs on both. Though the closing costs for HELOCs are generally lower than a traditional mortgage, it could add another 2% to 5% to your total loan cost.
- Refinancing could be tricky. In order to refinance a piggyback loan, the second mortgage lender has to approve it. You might run into trouble refinancing the primary mortgage if the piggyback loan lender doesn’t sign off.
Piggyback Loan Alternatives
If you aren’t sure whether a piggyback loan is the best financing option, consider these alternatives that may better meet your needs:
- Government-backed loan: Some types of loans that are backed by the federal government allow homebuyers to put down smaller amounts. FHA loans, for instance, require as little as 3.5% down, though you do have to pay mortgage insurance. VA and USDA loans don’t require any down payment if you meet a specific set of requirements.
- Down payment assistance program: If you’re a first-time homebuyer, you may qualify for special programs or grants that help lower the cost of a down payment. Often in this case, you wouldn’t have to worry about paying PMI or coming up with enough savings.
- Jumbo mortgage: Rather than taking out two separate loans, you do have the option to borrow from one, even If you exceed the conforming loan limits. In this case, you would have a jumbo loan and be subject to higher interest rates, but it may work out to be less expensive and more convenient in the long run.