Borrowers are looking for new ways to finance home purchases, and lenders are responding with piggyback loans. These usually consist of a conventional loan of 80% loan to value (LTV) and a home equity loan or line of credit of 10% LTV. The borrower takes out both loans simultaneously and provides 10% for the down payment.
Piggyback loans were common a few years ago, but lenders say today's version is different.
‘They were very popular prior to the financial meltdown, and they received negative publicity and fell out of favor,’ says Mike Corrigan, vice president of sales for Residential Finance, a Columbus, Ohio-based mortgage lender. ‘Today, the underwriting guidelines and qualifications are pretty strict.’
Corrigan says piggyback loans enable the borrower to avoid paying private mortgage insurance (PMI) required when the loan is more than 80% LTV. The interest rate on the second loan or HELOC is typically higher than on the first loan, but the consumer's monthly payment could be lower with the piggyback than with a conventional loan plus PMI.
To illustrate this, Corrigan offers two scenarios. A home has a purchase price of $250,000, and the borrower has a FICO score of 720 and puts down 10% as a down payment. In one scenario, the borrower gets a conventional loan for $225,000 at 3.5% interest. The principal plus interest would be $1,010.35, plus PMI of $91.88, for a total monthly payment of $1,102.23. With the piggyback scenario of the $225,000 loan amount, the payment on the 80% first mortgage would be $898.09 if the interest rate is 3.5%, and the 10% 30-year HELOC interest-only at 5.24% (prime +1.99%) is $137.76, so the total monthly payment would be $1,035.85, saving the borrower $66.38 a month.
The loans are serviced separately. ‘We service some loans, but we sell off the majority,’ Corrigan says. ‘Most likely, those two mortgages are going to end up at two different companies.’
Becky Walzak, president and CEO of Indianapolis-based Looking Glass Group LLC, which consults with mortgage lenders and settlement agencies, says another advantage to piggyback loans is that the interest associated with both loans is tax-deductible. That is a plus for borrowers, but some lenders will sit out this trend. When home values dropped during the mortgage crisis, second-lien lenders suffered losses when the equity disappeared.
‘Lenders are hesitant to take on this risk again,’ Walzak says.
But some lenders will take the risk, and they offer a piggyback option as an alternative to jumbo loans.
‘Jumbo loan investors have many additional underwriting overlays and much more restrictive guidelines,’ says Brian Thielicke, a partner and certified mortgage planning specialist with Cobalt Mortgage in Tukwila, Wash. These restrictions include lower debt-to-income ratios, possible reserve requirements, and multiple appraisals and reviews.
Thielicke says he knows of some regional lenders that are offering two simultaneous conventional loans, instead of one conventional plus one home equity. The second mortgage has an interest rate of 6.5% or 7%, and the bank does its own servicing.
As for the conventional and home equity piggyback, Thielicke says those loans are becoming popular, but they will not be a long-term solution.
‘In the next few years, these will likely go out of vogue due to presumption of the Federal Reserve raising the Fed funds rate, which directly impacts the interest rate on most HELOC products,’ he says. ‘This is a variable-rate product, which means once the Federal Reserve changes policy and starts increasing the Fed funds rate, these rates will potentially skyrocket.’
For now, some borrowers see piggybacking as a creative solution for other issues. Rick Cason, branch manager at Integrity Mortgage near Orlando, Fla., says some borrowers and lenders use the second loan as a short-term product.
‘Someone that is going to later sell their current home – and would like to take the proceeds and apply it to the home they just purchased – might want to jump on a first and second mortgage scenario, so they can get the lower rate of the first and then just pay off the second quickly,’ he says.
Cason notes that borrowers who can qualify for a jumbo loan might opt for that route, because the interest rates are low for a fixed-rate 30-year loan. With a piggyback loan, the HELOC has an adjustable rate.
There are regional differences, though. Cason says there has not been much of an appetite for second mortgages in Florida, as many companies that offered them went out of business.
‘Usually you will see this offered as a simultaneously offered loan program, but I haven't seen many banks offer this 'SIMO' loan over an 80 percent combined loan-to-value,’ he says.
Corrigan, however, thinks the piggyback loans will be one more product to offer as the housing market recovers.
‘We are getting to a point of a more normalized market,’ he says. ‘We will get more lenders and investors that will not be as gun-shy to offer different options, such as the piggyback loans.’
Nora Caley is a Denver-based freelance writer.