How Stacked Loans Work | Mortgages and advice

If you’re putting down a small down payment on your home, a piggyback loan could help you avoid additional charges on your mortgage. However, these types of loans are not without their own costs and drawbacks. Here’s what you need to know.

What is a piggyback loan?

Homebuyers use piggyback loans to avoid paying private mortgage insurance, which typically kicks in if your down payment is less than 20% of the home’s sale price. PMI acts as an insurance policy to protect the lender in the event of late payment or total default.

A piggyback mortgage deal typically offers a primary mortgage for 80% of the home’s value, plus a home equity product to make up the difference between your down payment and the remaining 20%.

The piggyback loan usually comes with a higher interest rate than the first mortgage, and the rate can be variable, meaning it can increase over time.

Stacked loans became popular during the housing boom of the early to mid-2000s. In 2006, for example, about 30% of New York homebuyers used one, according to a 2007 report from the NYU Furman Center.

The loan mix allowed aspiring homeowners to buy the homes they wanted and avoid PMI without putting 20% ​​or more in cash. But it also made their homes more vulnerable to default.

When the national housing bubble burst in the late 2000s, homeowners with less home equity were more likely to default than those with significant equity.

Piggyback mortgages still exist but are rare. “There has been a decline in popularity, but also a substantial tightening of guidelines by lenders offering these stacked second mortgages,” says Jeff Brown, branch manager and mortgage originator for Axia Home Loans.

And they don’t see much of a return, even with the recent spike in home prices. According to Ralph DiBugnara, CEO of Home Qualified, a digital real estate resource, “the need has been reduced with the expansion of mortgage products that require less than 20% down payment and do not require PMI.”

Types of stacked loans

There are several ways to structure a piggyback mortgage. Here’s how the different options break down based on your primary mortgage, piggyback loan, and down payment.

  • Ready 80/10/10. This option is worth considering on a conventional loan and involves a main mortgage covering 80% of the sale price, a piggyback loan financing 10% and a down payment covering the remaining 10%.
  • Ready 80/15/5. This option works the same way as the 80-10-10 loan, but instead of depositing 10% and borrowing the remaining 10% with a piggyback loan, you only deposit 5% and fund the remaining 15% with the second home loan. .
  • Ready 75/15/10. This option, which consists of a 15% loan and a 10% down payment, can be used when buying a condo. This is primarily because condominium mortgage rates tend to be higher if the loan-to-value ratio is above 75%.
  • 80/20 loan. This arrangement, which was popular during the years leading up to the 2007 housing crisis, required no down payment. You would simply take out a primary mortgage to finance 80% of the sale price and 20% with a secondary loan to cover the rest. This piggyback arrangement is no longer common, however.

Advantages and disadvantages of stacked loans

If you’re considering a piggyback mortgage, it’s important to understand both the pros and cons.

Advantages of stacked loans

It could save you money. PMI can cost between 0.3% and 1.5% of your loan amount per year. So if your mortgage is $250,000, you might have to pay between $750 and $3,750 in PMI premiums each year. This translates to a monthly payment of $62.50 to $312.50 plus the principal and interest payment to your lender, plus property taxes.

Depending on the cost of the second mortgage in monthly installments, you might end up paying less than you would with PMI. But it could easily go either way, DiBugnara says. “Some second mortgages used for piggyback loans will carry a much higher interest rate,” he adds. “In this case, it is very likely that the payment will be greater than a PMI payment.” Be sure to do the math to find out which option is best for your situation.

You can deduct the interest on both loans. The IRS allows you to deduct interest paid on up to $750,000 of qualifying mortgage debt ($375,000 if you’re married but file your taxes separately). This includes home equity loans and HELOCs used to buy, build, or significantly improve the home used as collateral.

Adding these savings into your calculation of whether a piggyback loan can save you money can make things more complicated. Plus, it can be hard to know exactly how much you could save — or even whether it makes sense to itemize your deductions and claim the mortgage interest deduction — unless you speak with a tax professional.

You may keep a HELOC for other purposes. A home equity loan is an installment loan, which means that you get the full amount of the loan as a lump sum and pay it back in equal installments. With a HELOC, however, you’ll get a form of revolving credit during the drawdown period, which you can repay and borrow again over time to pay for home improvements and other expenses.

Disadvantages of Layered Loans

Closing costs could reduce the value. In addition to paying the closing costs of your first mortgage, you may have to pay the closing costs of your home equity loan or HELOC. However, some lenders offer home equity products with low or no closing costs. You’ll want to know what the lender is charging so you can include it in your calculations.

Even if the closing costs are low, the math still may not work in your favor, and paying the PMI could end up being cheaper than taking out a second home loan.

This could make refinancing difficult. If you get your piggyback loan from a different lender than your first mortgage, which is typical, refinancing your home for cash or a lower interest rate could be more difficult. later.

This is because both lenders will have to accept the refinance unless you take out a refinance loan large enough to pay off the second mortgage. Convincing both lenders can be difficult, especially if the value of your home has gone down since you bought it.

The cost could increase over time. If the second loan you take out is a HELOC with variable interest rates, don’t base your calculations solely on the current cost of each option.

A variable interest rate may fluctuate with the market index interest rate. There is no way to know exactly how much a variable interest rate may cost you, as it is impossible to predict movements in market interest rates. If your budget is tight and you can’t handle your mortgage payments increasing over time, an adjustable rate piggyback loan may not be a good choice.

How to qualify for piggyback loans?

It can be difficult to qualify for a piggyback loan, as second mortgage lenders may have different eligibility criteria. Although the details may vary from lender to lender, here is what you will generally need to get approved for both loans:

  • Credit score. You will generally need a FICO score of 620 or higher for the primary mortgage, but the minimum for the secondary mortgage may be 680 or higher.
  • Debt to income ratio. Mortgage lenders like to see a debt-to-income ratio of 43% or less, and that includes both primary and secondary home loans.

Note that a smaller down payment will also generally result in higher interest rates.

Piggyback Loan Alternatives

Look for loans without PMI. Some lenders offer conventional loans without PMI even if you don’t have a 20% down payment. Depending on the lender, this may be limited to a first-time home buyer or a low-income program, or you may have to accept a slightly higher interest rate.

Like a piggyback loan, work out the numbers to make sure you’re not paying more in the long run with a higher rate than you would with PMI.

Pay off your balance quickly. Conventional mortgage lenders typically add PMI to your loan if your loan-to-value ratio is above 80%, but your loan balance should eventually fall below this threshold. Lenders are required by law to automatically remove the PMI once your LTV reaches 78% based on the original loan and home value.

If you’re expecting a large windfall or have the cash to make additional payments, this could help reduce your loan balance more quickly and get you to the point where you no longer need the insurance.

While you’re working to pay off your balance, if you think your home’s value has gone up and you’re at 80% or less, you can have the home appraised. If you are correct, you can ask the lender to manually remove the PMI.

Wait until you have saved enough. While there are ways to buy a home now and avoid PMI, you might be better off waiting until you have enough cash on hand for a 20% down payment.

Saving the 20% you need to avoid PMI can take years. But if you think you can save enough money quickly, it may be worth the wait.

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