Piggyback loans: an 80-10-10 instead of PMI

How the structure works

The CFPB describes a second mortgage, or junior lien, as a loan you take out using your house as collateral while you still have another loan secured by the same house. If you default and the home is sold, the first mortgage is paid first; the second lender is paid only from what is left. That higher risk is why second loans usually carry a higher interest rate than first mortgages.

Fannie Mae, which buys many first mortgages, allows subordinate financing behind its loans if the second lien is documented with a promissory note and a recorded security instrument and is clearly subordinate to the first. Lenders must disclose the second loan and its terms to Fannie Mae, the appraiser and the mortgage insurer, and they count it when calculating the combined loan-to-value.

The comparison in numbers

To compare fairly, you need the same down payment on both sides: one loan for 90% of the price with PMI, against an 80% first loan plus a 10% second loan.

The factor that often decides it: PMI can end

The monthly comparison at the start is only half the story. The CFPB explains that you can ask to cancel PMI once your balance is scheduled to reach 80% of the original value, and it generally ends automatically at 78% if you are current. Your payments shrink when it does.

A second mortgage does not cancel itself. You pay its interest until you pay it off. If you plan to stay a long time and expect to reach 80% equity in a reasonable period, PMI's ability to end can make the single loan cheaper overall even when it starts out a little more expensive. If you expect to pay off the second loan quickly, perhaps with a bonus or a home sale, the piggyback may win.

What to check about the second loan

Second loans vary more than first mortgages. Before you agree to one, find out:

• Fixed or variable? Some piggyback seconds are fixed-rate loans. Others are home equity lines of credit with rates that move with an index. The CFPB treats both as second mortgages; a variable rate adds payment risk.
• Term and balloon. A shorter term raises the payment. Some seconds have a balloon payment due before the balance is paid down. Fannie Mae's rules require that second liens behind its loans have regular payments covering at least the interest, and they generally treat a balloon due less than five years after the first mortgage's note date as unacceptable. Ask exactly when the balance is due.
• Closing costs. Two loans can mean two sets of fees. Compare the total on both Loan Estimates.
• Prepayment penalty. Make sure you can pay the second loan off early without a fee.

Refinancing and selling with a second lien

A second lien complicates later moves. When you refinance the first mortgage, the new lender will need the second lender to agree to stay in second position, called resubordination, or you will need to pay it off. Fannie Mae has specific resubordination rules for refinances. When you sell, both loans are paid off from the proceeds.

Who a piggyback suits

A piggyback can make sense when your PMI quote is high, for example because of your credit score, or when keeping the first loan at 80% avoids a jumbo loan or gets better pricing. It makes less sense when PMI quotes are low, when the second loan has a variable rate you are uneasy about, or when you expect to reach 80% equity fairly soon and could cancel PMI.

The bottom line

A piggyback loan swaps PMI for a second mortgage. Compare both with the same down payment, use real quotes, and remember that PMI can end while a second loan charges interest until it is repaid. Check the second loan's rate type, term, fees and prepayment terms, and think ahead to how it would affect a refinance.