Popularity and Pitfalls of Piggyback Loans

In 2004, around 42 percent of US homebuyers took advantage of a piggyback loan—up from only 20 percent in 2001. The majority of such loans were obtained in California, where housing prices have skyrocketed, according to a study funded by PMI Mortgage Insurance Co. (PMI), called “The Hidden Risks of Piggyback Lending.”

A piggyback loan is a second loan that covers the down payment, or part of it, when buying a home. This loan is generally taken out at the same time as the regular loan, albeit at a higher interest rate.

There are some benefits to this strategy. This way, the homebuyer can afford a higher-priced home. Also, the lender increases its earnings through additional interest payments. Buyers also avoid mortgage insurance rates.

Piggyback loans in Canada have also captured a significant market share. “A $190,000 mortgage (95 percent loan to value) that requires mortgage insurance ($6,200 in insurance premium) would cost $1,100 per month, while a mortgage for the same amount at a 5.24 percent first mortgage rate and an 8 percent second mortgage rate would cost $976 per month—lowering the monthly payment by $136,” according to the Canadian mortgage specialist firm Mortgage Intelligence.

Both PMI, the US home insurance provider, and GMAC Residential Funding of Canada are losing out on profits. Homeowners no longer need PMI or GMAC for home insurance. Piggyback loan interest payments are tax-deductible, while mortgage insurance is not. PMI is trying to recapture the market by pointing out possible pitfalls of piggyback loans. GMAC, on the other hand, devised a new interest-only mortgage.

“The greatest risk would come from a housing market recession,” says independent researcher Charles A. Calhoun in the PMI study. Buyers may lose their jobs during an economic downturn and become unable to pay down interest and principal on the mortgage.

“Piggyback lending is very popular and has been growing in popularity over the past three years,” says Shawn Welling, Senior Loan Officer of Celebration Lending Corp. of Houston, Texas. “Since 2003, 43 percent of our purchase transactions for owner-occupied property have been piggyback transactions.

“The approval process for a piggyback loan is generally the same as the approval process for a first mortgage. Many times, the piggyback loan is underwritten by the same company underwriting the first, so the process is streamlined.”

“The cost associated with a piggyback loan is another one of its many benefits. Generally, a piggyback loan will cost only a few hundred dollars, as the lender will accept the same property appraisal and charge little, if any, to underwrite and process the loan application,” says Welling. Based on risk, the interest rates vary. “If a borrower is avoiding mortgage insurance via a piggyback loan then he may pay a slightly higher [interest] rate on the 80 percent first mortgage plus a ‘piggybacked’ loan, versus actually making a 20 percent down payment.”

Marty Lapera is President of Frederick County Bank in Frederick, Maryland. “[We are] reluctant to do much of this type of lending,” he says, “for the simple reason that we consider it to be high-risk lending, particularly in an environment where residential real estate values have risen rapidly and when there is much talk about a real estate bubble. Many of the first mortgage loan programmes are tailor-made. These products may be interest-only loans, or adjustable rate loans, or a combination. A second [piggyback] mortgage behind one of these types of mortgages carries a huge amount of risk.”

After conducting extensive research, informed homebuyers are actively taking advantage of piggyback loans.

“I am more than happy with my piggyback loan,” says David Carter, a federal government employee and homebuyer in Richmond, Virginia. “I needed a bridge loan, as I had not sold my home yet, but had found exactly what I had been looking for. The loan process for the first and second loan took a total of three weeks, and I would recommend this type of loan to any of my friends.” “I took out the piggyback loan in 1997, as I did not have the full 20 percent down payment when I bought my first house,” says Steve Dell’Acqua, a homebuyer from Rockville, Maryland. “Any loan above 80 percent requires mortgage (PMI) insurance, adding premium payment to the monthly cost, which is not tax-deductible. [The interest on] a piggyback loan is slightly higher than the interest on the first loan, but it is tax-deductible. Also, it is almost impossible to remove PMI, even if the loan is paid down to below 80 percent. The documentation required to remove PMI is a nightmare.”

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.