Most of us remember riding on our daddy’s shoulders when we were children. As we grew up, dad would have done anything to help us out. His help often carried us through tough times and gave us opportunities we never would have gotten on our own. Some of us still need a little help. So, like a trusted father, banks are taking us up on their shoulders and giving us the chance to buy a home — even if we can’t come up with the full 20 percent down payment right away.
The piggyback loan is just as it sounds: banks give borrowers who can’t make a full 20 percent down payment the chance to take out a second “piggyback” mortgage to cover the difference. The three most common types of piggyback loans are the 80-20, the 80-10-10, and the 80-15-5.
A bank usually issues a primary mortgage for 80 percent of the cost of the home. To make up the shortfall in the absence of sufficient cash, a borrower might put 5 percent down and take out a piggyback mortgage for 15 percent of the cost of the home. Or she could put 10 percent down and take out a piggyback mortgage for the remaining 10 percent. Or the borrowers can even put zero down and take out a piggyback mortgage for the full 20 percent down payment.
When a borrower wants to take out a mortgage for more than 80 percent of the home’s price, they have to pay private mortgage insurance (PMI), which can be costly. Usually, a PMI payment is 0.5 percent of the loan. So for a $250,000 house, the PMI payment would come to about $108 per month. However, if a borrower takes out a piggyback mortgage, he avoids the PMI requirement.
In this sense, piggyback loans have been good for homebuyers but bad for the business of private mortgage insurance companies. It was more common to see homebuyers pay PMI before piggyback loans became popular in the 1990s. PMI guarantees that the bank does not lose out on the loan if the borrower defaults. Typically, a borrower who can’t pay a 20 percent down payment is considered more risky. PMI was – and still is – required until the borrower paid the loan down to about 78 percent of the home’s value, or until the home’s value rose sufficiently so that the borrower had more than 20 percent equity (requiring an appraisal and refinance). In the event of a foreclosure, PMI protects the lender.
Borrowers who can’t afford to pay the full 20-percent down payment on their house have two options: take out a piggyback loan or take out one loan and pay private mortgage insurance. Next week, we’ll discuss the advantages and disadvantages to piggyback loans in, “Is a piggyback loan right for me?”