Straight Talk About Real Estate

Is it better to get one home loan or a piggyback loan?

Let me explain: You want to buy a house for $400,000. You are going to put 5% down payment. You can get a 95% loan of $380,000, or you can get a piggyback loan. A piggyback loan is getting a first loan with a second loan “on its back” simultaneously. The first loan will be for 80% LTV, or $320,000, and the second will be for 15% of the loan, or $60,000. The CLTV is 95%, same as the one loan of 95%. The piggyback loan is also called 80/15/5. I hope you can figure out why. You can do the same if you are putting 10% down. It would be called 80/10/10. Or if you put no money down, you can get 80/20.

What are the advantages of getting a piggyback? No PMI - private mortgage insurance. Whenever your LTV exceeds 80%, the lender requires you to buy PMI. Because a loan of over 80% LTV is considered high risk of default, the PMI company will pay off your loan to the lender if you default. So PMI is an added expense to you. This expense is not tax deductible like mortgage interest.

A piggyback loan does not require PMI because the first loan is not over 80%. The second loan is assuming the risk if you default.

Another advantage is keeping the first loan within the conforming limits. In our scenerio, if you get a straight loan of $380,000, you have to pay jumbo loan rates whereas with a piggyback, you pay conforming loan rates with a loan of $320,000.

What are the disadvantages of a piggyback? Lenders charge an additional $195 to do this second loan. That’s a small price to pay. A greater disadvantage is the shorter term and the higher interest rate. It is usually a 15 year term. The interest rate is about 2-3% higher than the first loan. But it’s a small loan amount, so the difference in payment is not substantial.

I haven’t done a loan with PMI for a long time, ever since lenders began doing the piggyback. Overall, it is usually a good idea to do a piggyback rather than a straight first.

CLTV = Combined Loan To Value
Let’s say you house is valued at $400,000. You have a 1st trust deed of $300,000. You also have a 2nd loan of $80,000, and a 3rd of $20,000. The CLTV is the percentage of all loans to the value of the house. In this case, the CLTV is 100%.

If someone asks you to lend them $20,000 on a $400,000 house, it may sound alright. But if you know the CLTV, and it is 100%, it would be very high risk. Equity is the value of the house minus all the loans. In this case, there is the equity is zero. There is no equity. You may think $20,000 is not a big loan to lend someone on a house worth $400,000, but if you in the 3rd position, with a CLTV of 100%, it’s very high risk.

Let’s say the borrower defaults on any one of the loans. The house goes to sale and is sold for $380,000. The loan in 1st position will get paid off first, then the 2nd loan. There is nothing left to pay the 3rd loan. You are out of luck. That’s why it’s important to know the CLTV.

The higher the CLTV, the higher the risk, the higher the interest rate and fees will be charged to the borrower. Most of the loans in 3rd position or higher make their money upfront with fees because if the borrower defaults, chances are their loan will not get off. They have to cover that risk by charging high points and fees upfront.

Real estate agents and lenders use terms that are common in the business and they assume you know what they are talking about. I will explain a common term and its ramifications.

LTV = Loan-To-Value. This is the percentage of your loan to the value of the house. If you are getting a loan of $300,000, and the house is valued at $400,000, your LTV is 75%. The lower the LTV, the less risk to the lender. If you ever default on your loan, the lender can take your house, and they will be able to sell the house, get back the loan amount, plus a bit more. But mortgage lenders are not in the business of taking back and selling real estate. They would rather you just paid off the loan. With a low LTV, if you can’t make your payment, you can easily sell your house and pay off your loan, and most likely have money left over for yourself. So the lender are secure knowing that you will not allow it to get to the point of letting the lender take your property.

Now, the converse is also true if you have a high LTV. For example, you buy a house for $400,000. You put 5% down payment, $20,000. The loan amount is $380,000, or 95% LTV. After a year, you lost your job and cannot make the mortgage payment. If property value has not gone up, you sell your house for the same amount that you paid. You have enough to pay off the loan of $380,000, but $20,000 is not enough to pay closing costs, plus back payments, and penalties on the loan if you are behind. You would have to pay out of pocket to close escrow. Rather than doing that, you walk away and let the lender take the house. You will have a foreclosure on your record for 7 years.

If your LTV is low, some lenders will give you a little break on the interest rate.

Will homeowners lose mortgage interest deduction in the proposal by the tax reform panel? Don’t worry, I think some kind of tax benefits for homeowners will always remain, whether it’s mortgage interest deduction or credits. But the proposal, IF adopted, will decrease tax benefits for some. CNN Money explains it well.

The task of the tax reform panel is suppose to simply the tax code and make it more equitable. What they are proposing for mortgage interest is NOT more simple. And their definition of equitable seems to be make the rich pay more taxes.

No matter how they eventually reform the tax code, there will always be benefits to owning your own home. If you are still renting, find out what steps you can begin to make towards buying a home. Contact me.