Creative Home Financing: Piggyback Loan
Many homebuyers find themselves in the following situation: they want a better interest rate on a home loan, but do not have the ability to put down a 20% down payment. Or, counting on future earnings increases, want to buy slightly more house than they can strictly afford right now. Creative home financing is needed in order to get the home. There are different ways to do this, but one of the more popular ways right now is the piggyback loan. The piggyback loan offers, in effective, two mortgages at different rates. One is used to provide the down payments, and the other is the main financing for the house.
How it works:
1. Get a fixed rate mortgage for 30 years for 80% of the purchase price. Your interest rate will probably be right around 6.75% if you have pretty decent credit.
2. Get a 30/15 loan at a fixed rate for a higher rate, maybe around 8.25%, for the 20% “down payment” (your piggyback loan).
Your main financing for 80% of the purchase price will remain steady over the entire term. The 30/15 loan, however, is different. For the 15 years, the interest rate stays at the relatively tame 8.25%. However, when that 15 years are up, the interest rate balloons to a much higher fixed rate, maybe 11% or so. The idea is to use the creative home financing to get the home, but pay off the piggyback loan early (there are usually no prepayment penalties on these, but check to make sure), before the interest rate balloons.
Watching out
As with most techniques that involve creative home financing, the piggyback loan has its pitfalls. Such techniques are often used by lenders to convince you to buy more house than you can afford. The idea is to help you afford a larger home before you would otherwise be able to afford it. While this is a tantalizing idea, and can work out very well if your ideas of future earnings are realized, it can cause problems. You are, essentially, paying two mortgages when you go with the piggyback loan, and a few months down the road you might find that it is a difficult task. Additionally, if you should run into hardship instead of the projected wealth increase, you will be subject to ballooning payments for the last 15 years of your piggyback loan.
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