A purchase money second mortgage, often referred to as a piggyback loan, is a financing tool used by homebuyers to reduce upfront costs and avoid PMI, which lenders require when the down payment is less than 20% of the home’s purchase price.
Typically structured as an 80-10-10 loan, this arrangement involves:
- An 80% first mortgage, which is the primary home loan.
- A 10% second mortgage, the piggyback loan.
- A 10% cash down payment by the buyer.
By splitting the loan this way, borrowers maintain a primary mortgage with an 80% loan-to-value (LTV) ratio, avoiding PMI premiums that could add to monthly payments without building equity. However, they will have two separate mortgage payments: one for each loan.
For example, to buy a $400,000 home, instead of putting 20% down in cash, a buyer might put down 10% ($40,000) plus a 10% purchase money second mortgage ($40,000). The first mortgage would be $320,000, thereby sidestepping PMI.
While purchase money second mortgages can save money for qualified buyers, there are considerations:
- Second mortgages usually have higher interest rates than primary loans because they represent higher risk to lenders.
- Some second loans have variable rates or balloon payments, increasing financial unpredictability.
- Closing costs can be higher due to handling two loans simultaneously.
Interest on second mortgages may be tax-deductible subject to IRS limits similar to first mortgages, unlike PMI payments which typically are not deductible. This may enhance the financial appeal of piggyback loans.
Deciding between a purchase money second mortgage and paying PMI on a conventional single loan depends on your credit profile, financial situation, and how long you expect to stay in the home. Calculating total costs including all payments and fees is essential.
For more on avoiding PMI and mortgage insurance costs, see Private Mortgage Insurance (PMI), and to understand more about second mortgages, visit Second Mortgage.
According to IRS Publication 936, interest on a qualified home equity loan or second mortgage may be deductible if the loan proceeds are used to buy, build, or substantially improve your home that secures the loan.
Understanding these loans carefully and consulting with a mortgage professional can help you determine if a piggyback loan or traditional financing is the better option for your home purchase.
FAQs:
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What credit score is needed for a purchase money second mortgage?
Lenders typically look for a credit score of 680 or higher, often preferring scores in the mid to high 700s for better interest rates. -
Is a piggyback loan the same as a home equity loan or HELOC?
Purchase money second mortgages are taken out at home purchase, while home equity loans and home equity lines of credit (HELOCs) are usually taken later, after building equity. -
Can I pay off the second mortgage early?
Yes, but check for prepayment penalties. Paying off the higher-interest second mortgage early can save money on interest.
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