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How to manage your piggyback loan

Piggyback loans were designed to avoid private mortgage insurance (PMI) premiums, which are usually required with any mortgage exceeding 80 percent of a home’s value.

In the most common scenario, the homeowner puts 10 percent down, gets a mortgage for 80 percent of the home’s value, and then takes out a second loan for the remaining 10 percent. Although this second loan generally carries a rate one or two percentage points higher, the combined payment on the two loans may be less than one larger mortgage plus PMI. There can also be a tax break -- because the piggyback loan is a second mortgage, the interest may be tax-deductible.

If you bought a home with a low down payment and a piggyback loan, you may have questions about how to manage your second loan in combination with your first. Here are three options that can help you do so wisely:

1. Consider accelerating your payments.

Piggyback loans can be structured in several ways. One popular choice is a home equity line of credit (HELOC), which carries a variable rate that is typically higher than a first mortgage. A HELOC usually requires only small minimum payments, but paying it down more quickly can save you thousands in interest over the long run. If you can afford higher monthly payments or a lump-sum prepayment once a year, put those extra funds toward your HELOC rather than your first mortgage.

Other piggyback mortgages are balloon loans. which carry low monthly payments, but require a large lump sum to be paid at the end of a specified term, often five, seven or ten years. Whether it is wise to make prepayments on a balloon loan depends on the interest rate and length of the term. If the loan carries a high rate and will come due within a few years, knocking down the principal

with extra payments is usually wise. However, if your rate is fairly low and the loan does not come due for ten years, you may be better of investing your extra money instead.

2. Look for opportunities to refinance.

Since a piggyback loan typically carries a higher interest rate than your first mortgage, you may be able to save if you can refinance to a single mortgage. Even if you still need two loans, refinancing the piggyback alone may also be an option. You’ll need to take several factors into account:

Local market conditions. An upswing in housing prices in your neighborhood may have bumped your equity above 20 percent, making it possible to refinance your two loans into one.

Current mortgage rates. Obviously, the time to refinance is when rates are lower than when you obtained your mortgage. If the interest rate you currently have is lower than today’s rates, it may not make sense to refinance. However, even if rates have not dropped significantly, you might consider refinancing your piggyback loan to obtain better terms. If you have a balloon loan that is about to come due for example, you may want to consider refinancing now.

How long you plan to be in your home. As with any refinance, closing costs eat into your savings, so the longer you put off moving, the more sense it makes to obtain a new mortgage.

3. Consider paying PMI.

If interest rates were to start trending upward, a piggyback loan with an adjustable rate could become costly. Compare your current arrangement to the cost of refinancing to a single mortgage with less than 20 percent equity. You will have to pay PMI, of course, but market conditions (as well as a new tax break that makes PMI deductible for some borrowers) may make this the less costly option.

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