A mortgage that consists of two different loans for the same asset. The first loan is the bigger one with around 80% of the total value while the second loan is only 10%. The remaining 10% is a down payment.
Piggyback Mortgage Details
If you’re not familiar with the term “piggyback mortgage” it’s also called the 80/10/10 mortgage. If you’re going to buy an expensive house and use a mortgage to fully cover the expense, you have to pay an extra fee to your private mortgage insurance because of the loan to value ratio rule. The loan to value ratio states that a client has to pay an extra fee to the PMI (Private Mortgage Insurance) company if the loan value exceeds 80% of the targeted asset.
The piggyback mortgage is specifically designed to avoid this rule by splitting the mortgage into two separate mortgages. The first mortgage covers 80% (or lower) of the asset’s value, the second mortgage covers 10% of the asset’s value, while the remainder 10% is covered by the down payment. This is where the piggyback mortgage got its name – the smaller mortgage is piggybacking upon the bigger one.
Understanding the Two Mortgages
The big 80% mortgage is a long-duration fixed mortgage, while the small 10% mortgage is either a HELOC (Home Equity Line of Credit) or a home equity loan (although HELOC is much preferable). A home equity loan has a fixed rate and fixed payment, basically the mini-version of your 80% value loan. While the HELOC is a variable rate loan that can also be used like a credit card.
The piggyback mortgage combines the best of both worlds. You get a low-interest rate and low monthly payment from the big and long-duration 80% value mortgage and you get high financial flexibility from the small and short duration HELOC mortgage.
Example of A Piggyback Mortgage
Let’s say you want to buy a really nice house that has a price of $500K. Since you don’t have $500K in your pocket right now, naturally you’d apply for a mortgage. A conventional mortgage consists of 90% loan and 10% down payments depending on the firm.
With a conventional mortgage, you’d have a $450K mortgage and $50K down payment. This leads to an extra PMI fee due to the loan to value ratio rule. But with a piggybank mortgage, you’d get two separate mortgages consists of 80% loan, 10% loan, and 10% down payment. This prevents the extra PMI fee from occurring.
So, with a piggybank mortgage, you’d have two mortgages. The first is a fixed-rate mortgage valued at $400K. The second one is a HELOC valued at $50K. Finally, an extra $50K as a down payment.
Types of Piggyback Mortgage
The first type and the most common type of piggybank mortgage is the 80/10/10 mortgage. It consists of 80% loan, another 10% loan, then 10% down payment. The sole purpose is to avoid the extra PMI fee by keeping the loan to value ratio below 80%.
The second type is the 75/15/10 mortgage. It consists of 75% loan, another 15% loan, then 10% down payment. Why 75%? Because some assets or collaterals' loan to value ratio is lower than 80%. A condominium’s loan-to-value ratio is 75%. So, we have to lower the percentage of the first loan accordingly.
Furthermore, some mortgage firms offer better interest rates as the loan-to-value ratio goes down. So, the 75/15/10 could be a better choice than the mainstream 80/10/10. Make sure you consult their financial advisors to get the best rates.
Benefits of Piggyback Mortgage
The first and most important benefit of the piggyback mortgage is to avoid the PMI fee because the loan to value ratio is below 80% (or 75% in some cases). PMI fee is a big deal in a mortgage contract. From the $500K house example above, the PMI fee could reach up to $35K in total, or $580 monthly.
The second, smaller mortgage has a very interesting function. Because it’s a HELOC, you can use it like a credit card. Typically, you can draw from your HELOC only for 5 to 10 years, followed by the repayment period which lasts around 10 to 20 years.
Because your 10% loan is a home equity loan or HELOC, you can pay off that mortgage in full anytime you want. Perhaps you just received a massive influx of cash from your job? Use it to pay your HELOC to bring a sense of peace to your mind.
If you plan to buy a house to move there, you could use the funds from your old house’s sale to instantly (or greatly) pay off your second mortgage. Prioritizing to finish your second mortgage early can save you a lot of headaches in the long run.
Disadvantages of Piggyback Mortgage
Having a bad credit score is not an option for a piggyback mortgage. Because the piggyback mortgage consists of two mortgages, you need to qualify for both mortgages. Qualifying for a single mortgage can be hard if you had financial hiccups in the past, let alone qualifying for two mortgages.
If you choose a HELOC as your second mortgage, it will have a variable interest rate. This means that the interest rate can rise or fall depending on three factors: Credit score, debt-to-income ratio, and the loan-to-value ratio. This disadvantage is counteracted by the flexibility of HELOC, but this is still something you must pay attention to.
If you choose a home equity loan as your second mortgage, your monthly payment will be very high. The monthly payment is compounded with your 80% value loan, meaning if you got an unlucky financial downturn, you’re in deep trouble. A home equity loan is just too massive and inflexible to be an option, which is why a HELOC is a much better alternative.