A “piggyback loan” is a home financing option in which a property is purchased using more than one mortgage from two or more lenders. There are three common types of piggyback loans: the 80-10-10 loan, the 80-20 loan (also known as the 80-20-0 loan) and the 80-15-5 loan. In each of the aforementioned instances, the first number indicates that 80% of the home’s purchase price will be financed by a mortgage of lender number one; the second number indicates the percentage amount of a loan secured by a second mortgage with a different lender; and the third number indicates the down payment percentage.
For instance, the popular 80-20 loan is a situation in which 80% of the home loan is financed by one lender, 20% of the loan is financed by another lender and the homebuyer has zero down payment. And an 80-10-10 loan means that 80% of the home purchase price is financed by lender #1, 10% of the purchase price is financed by lender #2 and 10% of the purchase price is paid for in cash by the homebuyer-in the form of a down payment.
The Good News – The Pros
Piggyback loans are used so that homebuyers can qualify for more of a home. When more than one lender is involved in a single loan transaction, the entire loan risk is spread between two lenders. This means that a homebuyer with little or no down payment should have better luck with the loan approval process on a piggyback loan than they would with a single conventional loan.
Yet perhaps the biggest advantage of piggyback loans is that it allows homebuyers to purchase a home with less than 20% down payment. A piggyback lending program tends to level playing field, making homeownership a possibility for more potential buyers-especially first-time homebuyers who have little equity to use as a down payment.
A piggyback mortgage loan, which is also referred to as an 80-10-10s or 80/20 mortgage loans, is used when a borrower does not have the required 20 percent down payment available to buy a home. Most lenders require a borrower to come up with a down payment that is equal to 20 percent of the home’s value, giving the home an 80 percent loan to value. In cases where the borrower does not have the required down payment, the lender will require that private mortgage insurance (PMI) be taken out in order to protect the lender against loan default.
Private mortgage insurance, or PMI, protects the interest of the lender against loan default by the homeowner. When the home’s loan to value reaches 80 percent or below, the PMI requirement is eliminated for conventional loans.
Reasons to Think Twice -The Cons
As compared with standard home mortgage programs, combined rates for piggyback loans are often higher than standard loans. This is because of the risk amounts that each lender is assuming. The lender who is only financing 80% of the loan amount might be willing to drop their rates a bit, but the second lender-the one who is only financing 5% to 20% of the loan-doesn’t see much benefit from lending the money unless he can actualize a high interest return.
Also, many piggyback loans attach a large balloon payment at the end of a loan-an end-of-term payment that is substantially larger than the standard mortgage payments. This can be a bit hit, unless you plan ahead by setting aside some extra money every month.
And, since the premise of a piggyback loan is based on the idea of dual mortgages, if an emergency were to arise, getting an additional mortgage or home equity loan could be difficult, if not impossible.
Before using a piggyback mortgage to lower the loan to value ratio of the first mortgage to levels under 80% (to avoid PMI), a borrower should consider that a piggyback mortgage usually has a higher interest rate than a single, stand-alone first mortgage. If borrowers expect that their home will appreciate in value quickly (so that the LTV will not be higher than 80% for long), paying PMI for a period of time might be more economical than using a piggyback loan.
March 6, 2000, Revised November 20, 2006, December 21, 2006, February 23, 2007
100% mortgages are both a strength and weakness of the US system. Most borrowers who are able to make a down payment, should make a down payment, because the return on investment is very high.
“Is the ability of people to borrow without a down payment a strength of the US mortgage system, or a weakness?”
Both. Some families become successful home owners with the help of 100% loans who otherwise would be denied the benefits of home ownership. Others, who shouldn’t be home owners, are enticed to try 100% loans and they fail, at heavy cost to themselves and sometimes to their communities. Still a third group can afford to make a down payment but elect not to for bad reasons. Each of these groups will be discussed.
100% Mortgage Success Stories
The shortness of this paragraph is not indicative of small importance. I know there are many 100% mortgage success stories, I just don’t know how many or who they are. It is an unstudied phenomenon.
Mortgages With No Down Payment Have High Default Rates
This has been a finding of every study of mortgage defaults that I have ever seen. One reason is that home-owners who borrow the full value of their property have less to protect should economic adversity strike. If they lose their job, or if property values decline temporarily, they lose less from a default than borrowers with equity.
In addition, borrowers able to accumulate a down payment demonstrate budgetary discipline and the ability to plan ahead. People able to save money every month before they buy a home, are much more likely to meet their monthly mortgage obligations afterwards.
Why Do Lenders Make 100% Loans?
When property values are rising, as they have been with only short interruptions ever since World War II, the impetus for default is weakened. Rising values create equity in houses that were initially mortgaged to the hilt.
In recent years, lenders have also become more confident in their ability to assess the willingness and capacity of borrowers to repay their mortgages. Using credit scoring and other tools, they judge that it is safe to give less weight to an applicant’s ability to accumulate a down payment.
Lenders protect themselves, furthermore, by charging higher rates on 100% loans. The rate includes a “risk premium” to cover the losses lenders expect from the higher delinquencies and defaults on 100% loans.
Some Borrowers Who Take 100% Loans Should Have Remained Renters
Just because a lender is willing to offer a 100% loan doesn’t mean that the potential borrower should take it. The risk premiums protect lenders. Borrowers bear more of the costs of their failure than the lenders, and sometimes their communities suffer as well.
In a default, the borrower’s costs include not only loss of a home, but the costs of having to find another one and all the disruptions that that typically involves. Plus the borrower’s credit rating goes into the tank. And if many defaulters live in the same neighborhood, the neighborhood can also tank.
Some people are just not cut out to be home-owners. If you could have written either letter below, you are one of them.
“I hadn’t been in my house 3 weeks when the hot water heater stopped working. Only then did I realize that I hadn’t been given the name of the superintendent…who do I see to get it fixed?”
Responsibility is central to ownership, but people who have learned to depend on others often find it a difficult concept to grasp.
“…the man [who came to my door said my roof would fall in if it wasn’t replaced…it wouldn’t cost me any money for 3 months, and then just $250 a month…and now they tell me I have to pay them $4500 or they’ll take my house…I did sign a lot of complicated papers that I know I shouldn’t have….”
This home-owner has several characteristics, any one of which can cause trouble for a home owner; in combination, they will spell disaster every time. Among them:
*Deciding on repairs and improvements based on a solicitation by a huckster.
*Failing to seek out competitive bids.
*Assessing the cost based on the monthly payment, ignoring the interest rate and fees included in the loan.
*Signing documents that aren’t clearly understood.
Don’t Take a 100% Loan if You Can Make a Down Payment
“We are purchasing a $400,000 home that we want to finance with a 30-year fixed-rate mortgage. While we can more than afford the cost of a 20% down payment, I would prefer to keep my money in my investments instead. I was thinking of financing 100% (using an 80/20 to get out of paying PMI) but was unsure if this type of loan structure would result in a higher interest rate on the first mortgage?”
Taking a 100% loan with a piggyback – a first mortgage for 80% of value and a second mortgage for 20% — would result in a higher overall cost than an 80% loan with a 20% down payment. In part, the higher cost will be in the higher rate on the second mortgage. But in addition, either the rate on the first mortgage will be higher, or the total loan fees will be higher.
To illustrate, on October 17, 2006 I shopped for a purchase loan on a $400,000 property in California. If I put down 20%, I could get a 30-year $320,000 FRM at 5.75%, ½ point, and other lender fees of $4770. If I went 100% and kept the first mortgage rate at 5.75%, the rate on the second mortgage of $80,000 was 8.15%, total points were 1.5 and other fees were $6490.
Your intent is to invest the $80,000 that would otherwise go into a down payment. But a down payment is also an investment. The return consists of the reduction in upfront costs, lower interest payments in the future, and lower loan balances at the end of the period in which you expect to be in the house. I calculated the annual rate of return on investment in the case cited above, assuming you intended to be in the house for 7 years. It was 15.6% before tax, and it carries no risk. Investments that good are not available in the marketplace.
Why is the return so high? When you take a 100% loan, even though you have the capacity to make a down payment, you place yourself in the same risk class as borrowers who have not been able to save for a down payment, and who have negative equity in their house the day they move in. The default rate of such borrowers is relatively high, they pay for it in the price of the piggyback (or in mortgage insurance), and you pay the same price as them.
You wouldn’t have your 17-year old son purchase automobile insurance for your car. You wouldn’t buy life insurance and tell the insurer you are 10 years older than you really are. You shouldn’t take a 100% mortgage loan when you can afford to put 20% down.
The one possible exception is if the amount that would go into down payment can be invested to earn a very high return. This is discussed in Invest Xtra Cash in Securities or Larger Down Payment?
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Just as regulators, lawmakers and all forms of financial oversight boards are talking about new regulations to guard against mortgage fraud and another mortgage meltdown, there appears to be yet a new mortgage fraud out there today, allegedly perpetuated by agents of, yes, the big banks.I was first alerted to this by Jeremy Brandt, the CEO of several companies that bring short sale agents, investors and sellers together.
His companies include 1800CashOffer, HomeFlux.com and FastHomeOffer.com. Brandt has a huge network of short sale real estate agents, and over the past several months he’s been receiving all kinds of questions and complaints about trouble with second lien holders.
As we all know, during the housing boom, millions of Americans pulled cash out of their homes in the form of home equity loans and lines of credit. They also used “piggy back” loans in order to get even lower interest rates on their primary mortgages. Now, many of the borrowers in trouble, and many who are so far underwater on their loans that they don’t qualify for any refi or modification, are choosing short sales as a way out. (Short sales are when the lender allows the home to be sold for less than the value of the loan). About 12 percent of all home sales by the end of 2009 were short sales, according to the National Association of Realtors.
In order for a short sale with two loans to happen, the second lien holder has to drop the lien.
If they don’t, and there’s no short sale, the home goes to foreclosure and the first lien holder gets the house because second liens are subordinated debt to the primary loan.
In short, the second lien holder gets nothing. In order to get the second lien holder to drop the lien, the first lien holder generally negotiates some partial payment to the second lien holder. The second lien holder doesn’t have to agree, but more and more are doing so.
That’s all legal.
But here’s what’s not legal and what’s apparently happening quite often recently. Since many second lien holders are getting very little, they are now allegedly requesting money on the side from either real estate agents or the buyers in the short sale. When I say “on the side,” I mean in cash, off the HUD settlement statements, so the first lien holder doesn’t see it.
“They are pretty clear and pretty upfront about the fact that if the first lender knows they are getting paid, the first lender will kill the short sale,” says Brandt. “So these second lenders are asking for the payments off the closing documents, off the HUD statement, usually in a cashiers check prior to closing. Once they receive that payment, they will allow the short sale to go through, which according to RESPA laws and the lawyers that we have spoken to on the topic is not legal.”
(RESPA is the Real Estate Settlement Procedures Act, the 2008 law requiring that consumers receive disclosures at various times in the transaction. It outlaws kickbacks that increase the cost of settlement services. RESPA is a HUD consumer protection statute designed to help homebuyers be better shoppers in the home buying process, and is enforced by HUD. Read more about it here.).
I told RESPA specialist Brian Sullivan over at HUD about all this and he replied, “That’s a red flag!”
Brandt told me he’s heard from at least 200 agents that they’ve had these requests made by representatives of Citi Mortgage // [C 3.42 -0.09 (-2.56%) ]// , JP Morgan Chase // [JPM 43.68 -1.01 (-2.26%) ]// , Bank of America // [BAC 16.26 -0.56 (-3.33%) ]// and other large banks.
Most agents wouldn’t go on the record with me, for fear of retribution by the banks with whom they have to work every day. But one agent, Kayte Gentry, of Keller Williams Integrity First Realty, was brave enough to blow the whistle.
“I think it’s wrong, and I think somebody needs to hold them accountable, and every time I lose a house in foreclosure because of this, it hurts my client,” says Gentry matter-of-factly. “Aside from being illegal and a violation of RESPA, it’s immoral and truly it’s just sad for the client that it’s hurting.”
Gentry says she has had the requests made three times and claims she lost one sale because of it.
“The big banks that have recently made this request, specifically payments outside of the closing statement have been Citi Mortgage and JP Morgan Chase.”
JP Morgan Chase simply answered, “No Comment,” when I relayed the charge to their media representative.
Bank of America denied the practice to CNBC in a written statement:
“Bank of America enforces a policy that all disbursements are documented on the settlement statement for short sales. When we are servicing a first mortgage with a second lien held by another investor, if the second lien holder asks for off-HUD payments, we will not approve the transaction (if we have knowledge of it). It is also against Bank of America’s policy to accept off-HUD payments on its second liens.”
Citi ‘s reply was a bit more complicated:
“We work very hard to help distressed homeowners find solutions for their financial challenges. In our attempt to amicably resolve the debt, we will generally negotiate a reduced settlement with the homeowner in order to release a second lien. Unlike some lenders who refuse to reduce the payoffs on second liens, we choose to reduce the payoff amounts in some situations to assist the borrower. We do not provide instructions to settlement agents on how to fill out the settlement statement or any other closing documents, and we certainly do not require settlement agents or any other parties to violate applicable laws.”
“When we confront the lenders and tell them that this request is illegal and a violation of RESPA, they tell us it’s been cleared through legal and they don’t care. Do it anyway,” charges Gentry.
I personally heard a recording of a phone conversation between a short sale real estate agent and a second lien lender, during which the second lien lender clearly asked for cash outside of the settlement and threatened to kill the deal without it.
The real estate agent was rightly concerned and reluctant (the recording was given to me by Brandt who got it from the agent. The agent would provide no information on the lender, for fear of retribution):
AGENT: Well yes, I don’t want to lose my license, go to jail, I mean, I have to sign…
LENDER: You’re not going to lose your license – we have plenty of realtors who do this, who actually understand how this whole process goes – and they realize that OK, if I want to get this done, this will take place.”
I contacted the Treasury Department, HUD, FINCEN (Financial Crimes Enforcement Network) and the Federal Trade Commission, and none of their representatives could tell me of any active investigation into this. The folks at HUD said they’d be very interested to see my story.