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How Piggyback Loans Work

If you're making a small down payment on your home, a piggyback loan might help you avoid some extra costs on your mortgage. However, these types of loans aren't without their own costs and drawbacks.

What Is a Piggyback Loan?

A piggyback loan is a second mortgage — usually a home equity loan or home equity line of credit (HELOC) — that you take out alongside a mortgage. Homebuyers use piggyback loans to avoid paying private mortgage insurance (PMI), which typically kicks in if your down payment is below 20% of the home's selling price. PMI acts as an insurance policy to protect the lender if you fall behind on payments or default altogether.

A piggyback mortgage arrangement typically offers a primary mortgage for 80% of the home's value, plus a home equity product to make up the difference between your down payment and the remaining 20%. The piggyback loan usually comes with a higher interest rate than the first mortgage, and the rate can be variable, which means it can increase over time.

Piggyback loans became popular during the housing boom in the early to mid-2000s. In 2006, roughly 30% of homebuyers in New York City used one, according to a report from the NYU Furman Center. When the national housing bubble burst in the late 2000s, homeowners with less equity in their homes were more likely to default.

"There was a decrease in popularity but also a substantial tightening up of the guidelines by the lenders that offer those piggyback second mortgages."

— Jeff Brown, mortgage professional, NEXA Mortgage

Types of Piggyback Loans

Pros of Piggyback Loans

It Could Save You Money

PMI can cost between 0.3% and 1.5% of your loan amount annually. On a $250,000 mortgage, that's $750 to $3,750 per year — or $62.50 to $312.50 per month on top of principal and interest. Depending on the second mortgage's monthly payment, you could end up paying less than you would with PMI.

"Some second mortgages used for piggyback loans will carry a much higher interest rate. In that case, it's very likely that the payment will be higher than a PMI payment."

— Ralph DiBugnara, CEO, Home Qualified

You Can Deduct Interest From Both Loans

The IRS allows you to deduct interest paid on up to $750,000 in qualified mortgage debt ($375,000 if married filing separately). That includes home equity loans and HELOCs used to buy, build, or substantially improve the home used as collateral.

You Can Keep a HELOC for Other Purposes

A home equity loan gives you a lump sum paid back in equal installments. With a HELOC, you get a revolving line of credit during the draw period — you can pay it back and borrow again over time to pay for home improvements and other expenses.

Cons of Piggyback Loans

Closing Costs Could Reduce Value

In addition to paying closing costs on your first mortgage, you may need to pay closing costs on your home equity loan or HELOC. Even if closing costs are low, the math may still not work out in your favor, and paying PMI could end up being cheaper.

It Could Make Refinancing Tough

If you get your piggyback loan from a different lender — which is typical — refinancing your home later could be more difficult. Both lenders would need to agree to the refinance unless you're taking out a big enough loan to pay off the second mortgage.

The Cost Could Go Up Over Time

If the second loan is a HELOC with a variable interest rate, don't base your calculations solely on the current cost. A variable rate can fluctuate with the market index. If you're on a tight budget and can't handle payment increases, a variable-rate piggyback loan may not be a good choice.

How Do You Qualify for Piggyback Loans?

Qualifying for a piggyback loan can be difficult because second mortgage lenders may have different eligibility requirements.

• Credit score: You'll typically need a FICO score of 620 or higher for the primary mortgage, but the minimum for the secondary mortgage can be 680 or higher.
• Debt-to-income ratio: Mortgage lenders like to see a DTI of 43% or lower — including both the primary and secondary home loans.
• Note: A smaller down payment will also typically result in higher interest rates.

Piggyback Loan Alternatives

Look for Loans With No PMI

Some lenders offer conventional loans with no PMI even if you don't have a 20% down payment. This can be restricted to first-time homebuyer or low-income programs, or you may need to agree to a slightly higher interest rate. Run the numbers to make sure you're not paying more in the long term.

Pay Down Your Balance Quickly

Conventional mortgage lenders will usually add PMI if your loan-to-value ratio is higher than 80%, but lenders are required by law to automatically remove PMI once your LTV reaches 78% based on the original loan and home value. If your home's value has increased and you're at or below 80%, you can get an appraisal and request that the lender remove PMI manually.

Wait Until You've Saved Enough

While there are ways to buy a home now and avoid PMI, you might be better off waiting until you have enough cash on hand for a 20% down payment. Saving the 20% can take years, but if you think you can save enough quickly, it may be worth it to wait.

Originally published on U.S. News & World Report by Ben Luthi, edited by Sebastian Oliveira, reviewed by Whitney Blair Wyckoff · August 9, 2024.