What are piggyback loans?
Simply put, piggyback loans are a type of mortgage where you take out two separate loans for the same home. You may have heard piggyback loans referred to as an ‘80-10-10’ loan. This is because in a typical piggyback loan transaction the first loan is 80% of the value and the second loan is for 10% of the total home value- then the remaining 10% comes out of pocket for a down payment.
Are piggyback loans a smart choice?
it depends– just like with anything there are pros and cons to piggyback loans. Here are some common pro’s and con’s of piggyback loans.
A common reason that people choose piggyback loans, and one of the major advantages of piggyback loans, is that they do not require PMI (private mortgage insurance). Not having to pay for PMI allows investors to save money. However, PMI insurance can be beneficial if an investor was to default on their mortgage payment. Another advantage of piggyback loans is that they don’t require a full down payment, instead only a 10% down payment of the property value. If you cannot afford the typical 20% down payment, then piggy back loans are a great choice.
One of the disadvantages of piggyback loans is that the second loan often carries a higher interest rate than the first loan. With fluctuating interest rates, there is no way to determine what the interest rate will be on the second loan, so you may end up paying a substantially higher interest rate. Both loans also have separate closing costs and separate closing procedures, which can be more costly and timely than just taking out one mortgage.
What do the numbers say?
Typical piggy-back loans are structured as 80-10-10% or 80-15-5% loans.
Here’s an example:
- A property was purchased for $100,000
- The first mortgage would be for $80,000 at 5%
- The second would be $15,000 at 7%
- The monthly rent would be $1,000
- The traditional mortgage would require a gross yield of 9.04% resulting in a net cap rate of 7.94%
- With the assumed values, the traditional mortgage investment would result in an ROI of 22.09% for the first year
- The piggyback investment would result in an ROI of 67.47% due to the reduced investment for down payment
Our opinion on piggyback loans
Piggyback loans can be beneficial if you already have an established cash flow and a backup plan. Like with any investment, it is important to consider all of the risks and if piggyback loans are the right for you and your business. When considering piggyback loan keep in mind that the interest can change, so be prepared for the interest rate to increase.
Tips for piggyback loans
- consider paying off the first loan early to save on interest costs.
- For investors with poor credit, use stated income or stated income stated asset mortgages for the first lein and apply for a second lien separately. This will, however, likely result in higher interest rates on the first lien. This strategy is easier to finance if property appraises for more than the purchase price. The more constrained cash flows of this piggyback financing are better suited for properties with long-term leases already in place, such as commercial real estate. Investors considering this strategy should compare the amount they would have to pay in interest on the 2nd lien with the cost of PMI.
- Investors should know that they can also get high leverage loans with other methods such as FHA loans, but would be required to occupy the unit for six months in these instances