The Benefits of Piggyback Financing

Financing is one of the most important things you will need to consider when you are in the market for a new home.  To adequately prepare for a home purchase, you will need to analyze your finances and determine the amount that you can afford to pay upfront. You will also need to determine how much upfront cash you will have available for costs like the down payment, closing costs, insurances premiums, property taxes, and more.

Most homebuyers should plan to have a down payment equal to 20% of the home’s price.  In today’s world, buyers who plan to purchase more expensive homes often find themselves in a situation where they can comfortably afford the monthly payment, but cannot come up with the requisite 20% down payment.  This is becoming increasingly common and lenders now recognize the need to provide alternatives for good borrowers who simply cannot liquidate enough assets for a 20% down payment on an expensive home.

PMI
Traditionally, private mortgage insurance (PMI) was the only option for borrowers without a 20% cash reserve.  Unfortunately, PMI adds a significant premium to the monthly mortgage payment and does nothing for the borrower.  PMI protects the lender’s interests of the lender. In the event that a buyer with PMI defaults on a loan, the lender receives the balance of the outstanding mortgage.

Most buyers dislike PMI, but unfortunately it is not easy to eliminate lender’s requirement to have PMI. In some cases, PMI will no longer be required once the balance remaining on the borrower’s mortgage reaches 80% of the home’s purchase price.  In other cases, the PMI may be required throughout the entire loan repayment period or until the borrower petitions the lender to remove the requirement.

Piggyback borrowing is a less expensive alternative to help borrowers meet the 20% down payment requirement without getting PMI.  Piggyback borrowing occurs when the buyer has two separate mortgage loans. The first mortgage is for 80% of the home’s purchase price and the second mortgage is for the remaining 20% or some portion thereof. 

In the past, lenders had tight restrictions about borrowing in order to come up with the down-payment percentage, but piggyback borrowing options are becoming increasingly common.  Because piggyback second mortgages are almost always offered at competitive rates, they are much less expensive than other options.

Borrowers who wish to borrow piggyback mortgage loans must have very good credit and a strong financial situation in order to be eligible for such financing.  This is because if the lender does not require PMI and the borrower defaults on the loans, the lender does not any security.  Therefore, piggyback financing is not a guaranteed option for most borrowers who have less-than-perfect credit.

The advantages to those borrowers who do qualify, however, are significant. Although they have an additional mortgage payment each month, the costs of the second mortgage are usually less than those of PMI. And, as with the primary mortgage, the interest paid on a second mortgage is tax-deductible for the borrower.  In contrast, PMI costs are not tax-deductible expenses.

Line of Credit
Some lenders issue piggyback financing as a line of credit, as opposed to a standard second mortgage.  As the borrower pays down the principal of the line of credit, funds become available to the borrower should he or she like to make upgrades to their property or use the funds for some other purpose, including debt consolidation or educational expenses.  Borrowers who receive annual bonuses as part of their employment compensation find a significant advantage in paying off part or all of the second mortgage or line of credit. 

Naturally, this type of financing has some disadvantages.  For example, if a line of credit is the source of additional financing and the borrower continues to draw on that line of credit, he or she will need to continue making monthly payments on the outstanding balance.

Not all borrowers benefit equally from a second mortgage or line of credit.  Therefore, borrowers need to make careful preparations before deciding to accept a second mortgage.

Borrowers need to consider the anticipated appreciation in the home’s value.  If the home’s value is expected to increase rapidly, opting for PMI can be advantageous situation, because the PMI requirement will disappear sooner.  However, if a borrower selects the PMI option and the home does not increase in value at the expected rate, he or she will face continued PMI payments.

In general, piggyback financing is not available to buyers who participate in guaranteed loan programs sponsored by government agencies.  Borrowers need to consider the available options on their primary mortgage before accepting a specific loan program. A borrower who qualifies for a reduced-rate loan program, yet cannot produce the required upfront cash, may be better served by opting for piggyback financing to cover the upfront costs.

As a general rule, piggyback financing is available only to buyers who are purchasing a single-family home.  And most lenders limit the second mortgage amount to a maximum amount of $100,000.  This is adequate for most borrowers.

Interest-Only Loans
Some lenders provide second mortgages in the form of balloon or interest-only loans.  The monthly cost is significantly lower than that of a traditional second mortgage, but at the end of the loan period (usually ten or 15 years), the borrower must either pay off the loan in its entirety or refinance.  If interest rates drop during that time period, then the borrower would be wise to refinance. However, rising interest rates could easily spell trouble and higher payments for the borrower once the initial period expires.

Sometimes the lenders themselves issue PMI.  In this case, the mortgage payment is increased by a specified amount until the principal has dropped to 80% of the home’s purchase price.  Borrowers in this situation do not really notice the PMI addition until it is removed from their monthly payments.

Conclusion
Smart consumers investigate every possible option for financing their home purchase.  Lenders have many programs that make it possible for potential buyers to live the dream of homeownership, but the only person who can determine exactly what is right for the borrower is the borrower himself (or herself).

Talking to several lenders and researching your options carefully is your best defense against over-inflated payments.  Ideally, you want to make the required down payment and finance as little of your home as possible.  When this is not an option, know that programs are available to assist you. You just need to know where to look for the best programs.