Piggyback Loan vs. PMI: Which is the Better Option?

When buying a home with less than 20% down, you must choose between two options to finance the remainder of the purchase price: a piggyback loan or private mortgage insurance (PMI). While both enable homeownership sooner, you should understand some critical differences between piggyback loans and PMI before deciding which route to take.

What is a Piggyback Loan?

A piggyback loan refers to getting two mortgages when purchasing a home. The primary mortgage covers 80% of the purchase price, while the piggyback second mortgage covers 10-20% as a down payment substitute. This avoids the need for PMI while allowing you to buy with less than 20% down.

For example, buying a $300,000 home might get a $240,000 first mortgage covering 80% of the value. A $60,000 piggyback second mortgage would cover the remaining 20% down payment. You pay two separate monthly mortgage payments.

Benefits of Piggyback Loans

Some benefits of using a piggyback loan structure include:

Avoiding PMI: The key benefit is skipping private mortgage insurance by not borrowing over 80% in the first loan. PMI can add hundreds per month.
Potentially lower rates: The first mortgage may qualify for better interest rates since second mortgages often have higher rates.
Smaller down payment: You may only need 10-15% down instead of 20% to buy.
Faster equity: Two mortgage payments help you build home equity quicker.
Purchase higher-priced homes: Piggybacks allow buying more expensive homes by reducing the down payment requirement.

Drawbacks of Piggyback Loans

Some drawbacks to consider with piggyback home loans are:

Higher monthly costs: You’ll make two mortgage payments instead of one, increasing housing costs.
Tougher to qualify: Lenders scrutinize borrowers more for two loans. Good credit is essential.
Refinancing challenges: It can be difficult to refinance or modify piggyback mortgages later.
Closing costs and fees: Expect higher expenses and costs from getting two separate loans.
Debt-to-income factors: The two payments may impact debt-to-income ratios when qualifying.

Overall, piggyback loans provide an alternative method of financing a home with less cash down. But they come with tradeoffs to weigh against the PMI alternative.

What is Private Mortgage Insurance (PMI)?

Most lenders require private mortgage insurance if your down payment is less than 20% of the purchase price. PMI protects the lender if you default on a mortgage with low down payment equity.

With PMI, you pay an additional monthly premium and your regular mortgage payment. It’s usually around 0.5-1% of the total loan amount annually. On a $200,000 loan, that’s an extra $1000-2000 per year.

PMI stays in place until you build up 20% equity in the home. On FHA loans, it remains for the entire loan term. Conventional loans let you cancel PMI once you reach 20% equity through appreciation or extra payments.

Benefits of Private Mortgage Insurance

Some potential benefits of using private mortgage insurance are:

Lower payment requirements: You may only need 3-5% down with PMI.
More straightforward home buying process: Just one loan to qualify, approve, and close.
No second loan or lien: Only the primary lender has a lien on the property with PMI.
Easier to modify or refinance: No second loan simplifies future mortgage changes.
Lower upfront costs: PMI avoids secondary loan fees and closing costs.
No higher double loan rate: The mortgage has one interest rate instead of a costlier double loan rate.

Drawbacks of Private Mortgage Insurance

Some key drawbacks of PMI to consider are:

Monthly PMI premiums: This extra mortgage payment doesn’t build equity in your home.
Prepayment penalties: You may incur fees if paying below 80% LTV too quickly to cancel PMI.
No interest deduction: PMI premiums are not tax-deductible, while mortgage interest is deductible.
Loan term requirements: FHA loans require PMI for the entire term, while conventional loans let you cancel PMI later by reaching 20% equity.
Refinancing requirement: You may need to refinance at 20% equity to remove PMI if appreciation alone doesn’t get you there.
Difficulty removing: Lenders may make it difficult to cancel PMI even once you reach 20% equity.

PMI provides a tradeoff of lower upfront costs for higher monthly payments. It’s simpler logistically as a financing option but includes some long-term drawbacks.

Piggyback Loan vs PMI: Which is Better?

Whether a piggyback mortgage or private mortgage insurance works out better depends on your situation and priorities. Here are some key factors to help decide:

Upfront costs: PMI has lower upfront fees, while piggybacks require two closing costs.
Monthly payments: Piggybacks mean higher monthly payments from two mortgages. PMI has just one price but includes the PMI premium.
Interest rates: Piggybacks may allow better rates on the primary mortgage, but the second will be higher. PMI has one rate.
Credit score requirements: You’ll need higher credit scores for a piggyback, while PMI may be possible with lower scores.
Home price limits: Jumbo loan piggybacks let you buy a higher-priced home than conforming loan limits with PMI may allow.
Long-term costs: Piggybacks help build equity faster through two payments, while PMI increases total interest paid over the long run.
Ease of financing: Getting one loan with PMI is more straightforward than getting approved for and managing two mortgages.
Future refinancing: Piggybacks make refinancing more complex. PMI lets you more easily refinance as one loan.

Run the numbers for your mortgage amount and down payment, and consult mortgage professionals to understand the total costs. This will help determine if a piggyback loan or PMI better matches your home-buying plans and financial situation.

Who Should Consider a Piggyback Loan?

Piggyback loans work best for specific borrowers:

Strong credit: You’ll need scores around 700+ to qualify for two combined mortgages.
Buying a higher-priced home: Piggybacks let you purchase above conforming mortgage limits.
Want to avoid PMI: Use piggybacks if you don’t want extra monthly PMI premiums.
Plan to pay down quickly: Paying off debt faster helps reduce higher piggyback costs over time.
Desire lower rates: The split structure may allow a better rate on the primary balance.

Piggybacks cater to savvy borrowers who want alternative financing options and understand the tradeoffs.

Who Should Consider Private Mortgage Insurance?

PMI makes more sense for some borrowers:

Need lower down payment: PMI requires as little as 3-5% down, less cash upfront.
Lower credit scores: PMI may be available at lower scores that wouldn’t qualify for a piggyback.
Plan to move again soon: PMI avoidance of higher fees helps if not staying long term.
Want a more straightforward process? Getting one loan with PMI is more accessible than two piggyback mortgages.
Don’t mind higher monthly costs: The PMI premium may be worth it for lower upfront needs.

First-time homebuyers often opt for PMI to take advantage of buying sooner with less cash down.

The Pros and Cons of Getting a Piggyback Home Loan

Getting a piggyback home loan can offer several advantages and a few drawbacks. One of the main pros is that it allows borrowers to avoid paying for private mortgage insurance (PMI). This is particularly beneficial for those who cannot put down a 20% down payment on their home purchase. Additionally, a piggyback loan can be a strategic way to reduce the amount of a primary mortgage and potentially secure a better interest rate.

On the other hand, piggyback loans tend to have higher interest rates compared to traditional mortgages. Furthermore, since piggyback loans are typically taken out from a second lender, borrowers may face more complex paperwork and increased closing costs. Additionally, in the event of a slowdown in the housing market or a decrease in property values, borrowers with a piggyback loan can be at a higher risk of falling into negative equity. Therefore, it is crucial for individuals to carefully weigh the pros and cons before deciding on a piggyback home loan.

Consult a Mortgage Professional

Choosing between a piggyback loan or PMI depends on your financial specifics, credit profile, and home-buying plans. Speaking with an experienced mortgage professional is the best way to understand total costs and find the most advantageous structure for your situation.

Conclusion

Piggyback loans and private mortgage insurance provide viable options for buying a home sooner with less than 20% down. While piggybacks help avoid PMI, they also come with tradeoffs to consider. Understanding the pros and cons of your specific circumstances will help you decide on financing your home purchase. With the proper mortgage structure, you can move into your dream home even with less than 20% to put down at closing.

SOURCE:
Termination of Conventional Mortgage Insurance
MGIC rate cards
Mortgage Insurance Coverage Requirements