A piggyback loan is a type of mortgage that involves combining a construction loan with a permanent loan commitment. Alternatively, it can also refer to a mortgage held by more than one lender, where one lender holds the rights of others in subordination. This financial tool is used primarily in real estate to finance the purchase or construction of property with favorable terms and conditions.
Types of Piggyback Loans
1. 80-10-10 Loan
The most common type of piggyback loan, where:
- 80% of the property’s value is financed with a first mortgage.
- 10% comes from a second mortgage.
- 10% is paid as a down payment by the borrower.
2. 75-15-10 Loan
Another variation where:
- 75% is financed with a first mortgage.
- 15% comes from a second mortgage.
- 10% is paid as a down payment.
Special Considerations
Subordination
In cases where multiple lenders are involved, one lender may hold the primary lien, and others are subordinated. Subordination agreements prioritize the repayment hierarchy, ensuring the primary lender has the first claim on the property in case of default.
Avoiding PMI
One of the main advantages of piggyback loans is to avoid private mortgage insurance (PMI), which is required when a borrower’s down payment is less than 20% of the home’s value.
Examples and Applications
Construction to Permanent Loan
A piggyback loan can be structured to finance the construction of a property. Initially, it starts as a construction loan and, once the construction is completed, it converts into a permanent loan commitment.
Blending Loans
In high-cost real estate markets, home buyers may use a piggyback loan to avoid higher interest loans and PMI, making homeownership more affordable.
Historical Context
Piggyback loans gained popularity in the lead-up to the 2008 financial crisis as they allowed borrowers to finance home purchases with minimal down payments. Post-crisis regulations have made them less common but still viable for certain borrowers.
Comparisons
Piggyback Loan vs. Single Loan
Compared to a single loan, a piggyback loan can provide better terms by avoiding PMI and offering more flexible financing options. However, they come with complications of managing multiple loans and lenders.
Piggyback Loan vs. HELOC
A Home Equity Line of Credit (HELOC) can serve a similar purpose but is typically used for secondary financing after purchase, whereas a piggyback is arranged concurrently with the primary mortgage.
Related Terms and Definitions
Construction Loan
A short-term loan used to finance the building of a property.
Permanent Loan
A long-term loan that replaces previous financing upon completion of the construction phase.
Subordination
An agreement that ranks one debt below another in priority for collecting repayment from a debtor.
FAQs
Q: Why would someone opt for a piggyback loan?
Q: Are piggyback loans still available today?
Q: What risks are associated with piggyback loans?
References
- Investopedia. (2023). Piggyback Loan
- Bankrate. (2023). What is a Piggyback Loan?
Summary
Piggyback loans offer an alternative financing strategy for homebuyers, particularly in avoiding PMI and securing favorable loan terms. Understanding the structure, benefits, and potential risks can help borrowers make informed financial decisions and optimize their mortgage strategy.
This comprehensive entry on piggyback loans should provide readers with a solid foundation for understanding this financial tool’s intricacies and applications.
