If you’re in the market for a home, is a piggyback loan a good option to take?

Q: We want to buy a home this fall and avoid mortgage insurance when we do. Our real estate broker suggests that we look into piggyback financing. This will allow us to buy with just 10% down and not face mortgage insurance costs. Is this a good strategy? A: Many buyers are unable to save the 20% down that lenders like to see. They buy with little down with backing from a strong third party such as the FHA, VA,or a private mortgage insurance (MI) company. Third-party programs allow you to purchase with as little as 3.5% down (FHA), 0% down (for VA-qualified borrowers), or 3% down with the Fannie Mae HomeReady program or the Freddie Mac Home Possible loan. There is a cost to getting third-party assistance. Imagine you finance a $250,000 property with an FHA loan — a popular option. There will be a 3% interest rate in this case, plus you’ll need $8,750 for the down payment. You will have a monthly cost for the principal and interest of $1,035. Also, there will be a 1.75% upfront mortgage insurance premium or $4,222. This is a cost that can be added to the loan and not paid in cash. Lastly, there will also be a .85% annual MIP that costs $174 per month in this example. The total monthly cost for principal, interest and mortgage insurance is $1,209 ($1,035 + $174). Closing costs and monthly expenses for taxes and insurance are extra. The FHA program has allowed tens of millions of people to buy real estate, but a piggyback loan will have lower monthly expenses — but only if you qualify. With a piggyback loan, we have a $250,000 property. The home is bought with 20% down. There’s a $200,000 mortgage — 80% of the purchase price — at 3%. The monthly payment for principal and interest is $843.21. Next we get a 10% second loan, $25,000 at 3%. Over 30 years, the monthly payment is $105.40. The total monthly payment with two loans is $948.61 ($843.21 + $105.40). That’s a savings of $260.39 per month or $3,125 a year when compared with the FHA loan. Finally, we buy with 10% down in cash. This gives us 80-10-10 financing. A piggyback loan is attractive to the first lender — the first lien holder — because they only financed 80% of the purchase price. For the second lender — the second lien holder — the deal is riskier. If there’s a foreclosure, the first lien must be repaid entirely before any money goes to the second lender. While piggyback loans can be attractive, there are some practical barriers. First, not everyone has 10% down. Second, in the coronavirus economy, it can be tough to get a second loan. Some lenders only want to originate first loans at this time. Third, as a borrower, you will have to qualify for financing based on the total cost of both loans. This may not be a big hurdle since the monthly cost of piggyback funding is often less than the expense for a loan backed with mortgage insurance. Fourth, you need really good credit. Fifth, your monthly debt-to-income ratio (DTI) must be low, preferably 43% or less. Sixth, it may be that the second loan will have an adjustable rate or a short term, say 10 years rather than 30. That means a balloon payment can loom ahead. With a $25,000 mortgage at 3%, the balloon payment after 10 years will be about $19,000. Seventh, you might have to pay a higher rate for the second loan simply because it represents more lender risk. For more details and information, speak with lenders. Ask about such matters as up-front expenses, interest rates and annual percentage rates (APRs), total monthly costs, and whether the second loan has a balloon payment.