Piggyback Loan: Detailed Explanation
A piggyback loan can refer to two different financial arrangements in real estate financing:
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Combination of Construction Loan and Permanent Loan Commitment: This type of piggyback loan involves a permanent lender issuing a commitment at a specific interest rate that becomes effective upon the completion of the construction. This assures that the loan will be borrowed even if rates are lower upon completion, thus providing certainty for both the borrower and the lender.
- Example: The permanent lender commits to an 8% interest rate, which becomes effective once construction is completed. This commitment is piggybacked onto the construction loan ensuring that the permanent loan must be utilized to pay off the construction loan.
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Mortgage Held by More Than One Lender with Subordination: In this arrangement, one lender holds the rights of others in subordination. This type is often utilized to avoid private mortgage insurance. Typically, the primary lender provides the main portion of the loan while a secondary lender contributes a smaller, subordinate loan.
- Example: A home is purchased with 90% financing, where 80% is funded by a Savings and Loan Association and the remaining 10% by an individual lender. The Savings and Loan Association holds priority in the event of a foreclosure. This setup helps the borrower to avoid Private Mortgage Insurance (PMI).
Examples of Piggyback Loans
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Purchase of $400,000 Home:
- Primary Loan: $320,000 (80% by a Credit Union)
- Secondary Loan: $40,000 (10% by an individual lender)
- Borrower’s Down Payment: $40,000
- Benefit: Avoids PMI, lower initial out-of-pocket expenses.
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100/80 Construction-to-Permanent Loan:
- Construction Loan: $300,000 at 6.5%
- Permanent Loan: $300,000 at 8%, committed upon construction completion.
- Benefit: Faces no interest rate risk post-construction, financial certainty.
Frequently Asked Questions
What are the benefits of a piggyback loan?
- Avoidance of Private Mortgage Insurance (PMI)
- Potential to secure better interest rates
- Flexibility in structuring the loan for tax benefits
- Lower initial capital or down payments needed from the borrower
What are the risks associated with a piggyback loan?
- Potential for higher total interest costs
- Complexity of managing multiple loans
- Greater challenge in qualifying for secondary or additional loans
- The distinct possibility of higher payments if the secondary loan carries a higher interest rate
Who typically uses piggyback loans?
Piggyback loans are often utilized by borrowers who want to avoid PMI or those who require more financing than a single mortgage could offer without stretching loan-to-value limits.
How does a piggyback loan differ from a second mortgage?
While a second mortgage simply adds another lien on the property, a piggyback loan typically implies that both the primary and secondary loans were arranged simultaneously for purchases or construction purposes.
Related Terms
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Construction Loan: A short-term loan used to finance the building of a property, replaced by a permanent loan upon project completion.
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Permanent Loan Commitment: A commitment from a lender to provide a loan when certain conditions, like the completion of construction, are met.
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Subordination: The ranking of different loans, with primary loans getting priority over secondary loans.
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Private Mortgage Insurance (PMI): Insurance required by lenders for borrowers who finance more than 80% of the home’s value.
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80-10-10 Mortgage: A common type of piggyback loan where 80% of the property price is covered by the first mortgage, 10% by a secondary loan, and 10% by the borrower’s down payment.
Online Resources
- Investopedia: Piggyback Loan
- Bankrate: Piggyback Loan Overview
- National Association of Realtors: Loan Types
References
- Ginsberg, Joel S. “Real Estate Financing,” third edition, 2021.
Suggested Books
- “Navigating Real Estate Financing” by Janet Portman
- “Real Estate Finance & Investments” by William Brueggeman and Jeffrey Fisher
- “The Real Estate Wholesaling Bible” by Than Merrill
