What Is a Piggyback Loan and How Does It Work?

A piggyback loan involves securing two separate mortgage loans simultaneously to purchase a single property. This strategy helps prospective homeowners navigate financial requirements often associated with property acquisition. By combining a primary mortgage with a secondary loan, borrowers can structure their financing to meet individual circumstances. This method offers an alternative to a conventional single mortgage, providing flexibility in managing upfront costs and loan terms.

What is a Piggyback Loan?

A piggyback loan is characterized by the concurrent use of two distinct loans to finance a home purchase. Instead of obtaining one large mortgage, a borrower takes out a primary, or first, mortgage and a smaller, secondary loan. This secondary loan “piggybacks” on the first, meaning it is secured by the same property but holds a subordinate lien position. For instance, a common arrangement might involve a first mortgage covering 80% of the home’s value, a second loan for 10%, and the borrower providing a 10% down payment.

This financial structure allows for the allocation of the home’s purchase price across different financing instruments. The first mortgage typically covers the largest portion, establishing the primary lien on the property. The second loan covers an additional segment of the home’s value, positioned as a junior lien. This dual-loan approach provides a pathway to homeownership for individuals who may not have a substantial down payment available. It splits the financing into manageable components, each with its own terms and conditions.

How Piggyback Loans are Structured

The structure of piggyback loans typically involves a conventional first mortgage, which finances the majority of the home’s purchase price, often around 80% of the property’s value. This primary loan secures the top lien position, meaning it would be satisfied first in the event of a foreclosure. The remaining portion of the home’s value, beyond the initial down payment, is covered by a second loan. This secondary loan can take different forms, most commonly a Home Equity Line of Credit (HELOC) or a fixed-rate second mortgage.

A HELOC functions like a revolving credit line, allowing borrowers to draw funds as needed up to a predetermined limit, often with a variable interest rate. It includes an initial draw period followed by a repayment period. In contrast, a fixed-rate second mortgage provides a lump sum at closing, with a set interest rate and a fixed repayment schedule over a specified term. Common piggyback structures are expressed as percentages, such as an 80/10/10 or an 80/15/5, where the first number represents the first mortgage percentage, the second represents the second loan percentage, and the third indicates the borrower’s cash down payment.

Why Borrowers Use Piggyback Loans

A primary reason borrowers utilize piggyback loans is to avoid Private Mortgage Insurance (PMI). Lenders typically require PMI on conventional mortgages when a borrower’s down payment is less than 20% of the home’s purchase price. PMI protects the lender against potential losses if the borrower defaults. By structuring a piggyback loan with an 80% first mortgage, the borrower finances 80% of the home’s value, circumventing the PMI requirement.

This strategy allows individuals to purchase a home with a smaller upfront cash payment, such as 10% or 15%, without incurring the monthly cost of PMI. PMI premiums can range from approximately 0.5% to 1.86% annually of the original loan amount, making its avoidance a significant financial advantage. Beyond PMI avoidance, some borrowers use this structure to preserve cash reserves for other investments or emergencies. It can also enable qualification for a larger overall loan amount than accessible with a single mortgage, offering greater purchasing power.

Key Financial Considerations

The second loan, due to its subordinate lien position, typically carries a higher interest rate than the first mortgage. This increased rate compensates the lender for higher risk, as the first mortgage holder would be repaid first in the event of default. Borrowers should account for two distinct monthly payments, which may have different due dates and terms, adding complexity to personal financial management.

Both loans come with closing costs, including origination fees, appraisal fees, and title-related charges. Origination fees typically range from 0.5% to 1% of each loan amount, while total closing costs can range from 2% to 5% of the primary mortgage, with additional costs for the second loan. The presence of two loans can also impact a borrower’s Debt-to-Income (DTI) ratio, affecting future borrowing capacity. Interest paid on both mortgages may be deductible, subject to IRS limits for loans incurred after December 15, 2017. Consulting a tax professional is advisable.