Piggyback loans offer good and bad points for home buyers

Eliminating private mortgage insurance is one of the benefits

There are several drawbacks to buying a house; one of the major ones is trying to come up with the necessary down payment required. Lenders don’t like to lend 100% of the price of a home. They want the buyers to have a cash interest in the property, as well. This helps protect the lender, as foreclosure could cost the homeowner money. It’s tough coming up with a 20% down payment, though, and if your down payment is less than 20%, then you will have to pay private mortgage insurance in order to protect the lender against default. Private mortgage insurance, or PMI, is a nuisance that few homeowners like to pay.

Often the solution for buyers who are strapped for cash and do not want to pay for PMI is what is known as a piggyback loan. At the time of closing, lenders issue not one, but two loans - one for 80% of the purchase price, and one for any sum up to the remaining 20%. With such an arrangement, it could be possible to buy without a down payment This second loan is generally issued as a home equity line of credit against the portion of the home’s value that is not covered by the primary mortgage. It serves several purposes to do it this way - the lender has security against the other 20% of the property and the homeowner can avoid the often-expensive PMI payments.

There are some downsides to financing this way, however, and anyone thinking about using a piggyback loan scenario should consider them.

While the primary mortgage may have a fixed rate of interest, and thus, fixed monthly payment, the second loan, the line of credit will not. Lines of credit are flexible lending tools that are often structured around variable interest rates and flexible repayment schedules. The variable rate can become a problem if interest rates rise. As they have been steadily rising for the past two years, financing with a variable rate of interest is becoming less and less popular with home buyers. Some homeowners are finding that their payments on their home equity lines of credit have doubled in the past three years, and that trend could continue. If you finance with a piggyback loan, you may find that the second mortgage could become unaffordable fairly quickly.

An additional problem for those seeking to finance this way is that your home will be completely leveraged. This is a problem if you should decide later that it would be advantageous to finance some large purchase, such as a remodeling or debt consolidation, using a home equity loan. If you have a piggyback loan, you likely will not have any equity in your home against which you can borrow. Not that it would matter, because even if you did, you would have a difficult time finding a lender who would be eager to set you up with a third mortgage.

In some situations, a piggyback loan might still be a useful tool to get you into the home of your dreams. For instance, if you work at a job that provides you with a large, end of year bonus, but you need to buy early in the year, then going with a piggyback loan might work if you can use the bonus to retire, or seriously pay down, the second loan.