What Is a Piggyback Mortgage and How Does It Work?

A piggyback mortgage is a financing strategy where a homebuyer obtains two separate loans simultaneously to purchase a single property. This approach often helps manage the initial cash outlay for a down payment or avoid specific insurance requirements that apply to conventional mortgages.

Understanding the Two-Loan Structure

A piggyback mortgage involves a primary mortgage, which holds the first lien position, and a secondary loan, which holds a second lien position on the property. The first lien mortgage covers the largest portion of the home’s purchase price, typically up to 80% of the value.

The secondary loan, often a home equity line of credit (HELOC) or a fixed-rate home equity loan, covers an additional portion of the home’s value. A common structure is an 80-10-10 arrangement, where the first mortgage covers 80% of the home’s value, the second loan covers 10%, and the remaining 10% is provided by the buyer as a down payment. Other configurations, such as an 80-15-5 structure, are also possible, depending on the borrower’s financial situation and lender offerings.

The first mortgage lender has the primary claim on the property in the event of default or foreclosure. If the borrower cannot make payments, proceeds from the sale of the home would first go to satisfy the outstanding balance of the first mortgage. Only after the first lien holder is fully compensated would the second lien holder receive any funds.

The two loans, when combined with the down payment, cover the full purchase price of the property. For example, in an 80-10-10 structure, if a home costs $400,000, the first mortgage would be $320,000, the second loan would be $40,000, and the buyer would contribute a $40,000 down payment.

Primary Applications of a Piggyback Mortgage

One of the primary reasons borrowers choose a piggyback mortgage structure is to avoid Private Mortgage Insurance (PMI). Lenders typically require PMI on conventional mortgages when the borrower’s down payment is less than 20% of the home’s purchase price, meaning the loan-to-value (LTV) ratio exceeds 80%. PMI is an additional monthly cost designed to protect the lender in case the borrower defaults on the loan. By keeping the first mortgage at or below 80% of the home’s value, even with a smaller total down payment, the requirement for PMI on that primary loan is bypassed.

For instance, if a homebuyer only has a 10% down payment, a traditional single mortgage would result in a 90% LTV, triggering PMI. However, with an 80-10-10 piggyback loan, the first mortgage is 80% LTV, the second loan covers the next 10%, and the buyer provides the remaining 10% down payment. This configuration effectively splits the financing, allowing the buyer to avoid the recurring PMI premium associated with the larger portion of the loan. While the second loan will have its own interest and potential closing costs, these costs can sometimes be less than the cumulative expense of PMI over time.

This strategy also enables borrowers to purchase a home with a lower overall cash down payment than would be necessary to avoid PMI with a single mortgage. Many homebuyers may have strong credit scores and stable incomes but lack the substantial savings for a 20% down payment. A piggyback mortgage provides a pathway to homeownership without needing to save an additional 10% or 15% of the home’s value upfront. For example, on a $400,000 home, avoiding PMI traditionally would require an $80,000 down payment, whereas a piggyback loan might allow for a $40,000 down payment while still sidestepping PMI on the primary loan.

This approach is commonly applied in scenarios where market conditions or personal financial situations make a large down payment challenging. It offers flexibility for individuals who are otherwise financially qualified but prefer to keep more of their liquid assets or do not have sufficient funds for a traditional 20% down payment.

Financial Aspects of Managing Multiple Loans

Managing a piggyback mortgage involves handling two distinct monthly payments, one for each loan. The primary mortgage payment covers principal and interest on the larger loan amount, while the secondary loan payment addresses its own principal and interest. These payments are typically due on different schedules or to different financial institutions, requiring careful attention to ensure both obligations are met on time.

The interest rates for the first and second loans can differ considerably. The primary mortgage usually has a lower interest rate, reflecting its first lien position and lower risk to the lender. The secondary loan, being in a subordinate position, often carries a higher interest rate to compensate for the increased risk. For example, while a first mortgage might have a fixed rate, the second loan, especially if it’s a HELOC, could have a variable interest rate that fluctuates with market conditions, such as changes in the prime rate.

Each of the two loans accrues interest independently and follows its own amortization schedule. The amortization period for the second loan is often shorter than that of the primary mortgage, meaning it will be paid off more quickly. For instance, a first mortgage might be amortized over 30 years, while a second loan could have a 10- or 15-year repayment term. This difference in terms affects the monthly payment amount for each loan and the total interest paid over the life of each loan.

Payments made on each loan are allocated between principal and interest according to their respective amortization schedules. Early payments on both loans will primarily cover interest, with a smaller portion reducing the principal balance. As the loan terms progress, a larger portion of each payment goes towards reducing the principal. Borrowers should monitor the balances and terms of both loans to understand their total debt obligation and progress toward homeownership.