A piggyback is a second mortgage taken out at the same time as a first mortgage, as a way of borrowing a larger total amount. The first mortgage is for 80 percent of property value, and therefore does not require mortgage insurance, while the piggyback is for 5 percent, 10 percent, 15 percent or 20 percent of value. Instead of a mortgage insurance premium, the borrower pays a higher rate on the piggyback than on the first mortgage.

Whether a piggyback saves the borrower money relative to mortgage insurance depends on many factors, including the rate on the piggyback relative to that on the first mortgage. These factors are pulled together in calculator 13a on my Web site.

During the years 2000-2006, the advantage seemed to favor piggybacks, and they grew rapidly at the expense of mortgage insurance. It helped that interest on piggybacks was tax-deductible and mortgage insurance premiums were not. In addition, because of the marked appreciation in home prices during this period, piggybacks were underpriced.

Because a piggyback lender, in event of a foreclosure, recovers only what is left after the first mortgage lender is paid off, the risk of loss on a piggyback is critically dependent on what happens to home prices. With prices rising 7 percent or more a year as they did during 2000-2006, even a 20 percent piggyback acquires a comfortable equity cushion after a few years. It appears that piggyback lenders, sharing the euphoria that pervaded the entire market, priced on the assumption that prices would continue to rise. I have called this "disaster myopia."

When the disaster struck in 2007, the default rate on piggybacks soared, and investors in second mortgages began paying a stiff price for their mistake. With home prices declining, there is no equity protecting many of these seconds, and it doesn’t pay the lender to foreclose. In some cases, lenders are writing the loans off, though the borrower remains liable and cannot sell the house without a sign-off from the lender.

Many of the borrowers who are having payment problems with their first mortgage are regretting that they had earlier selected a piggyback over mortgage insurance. If the two mortgages are held by different lenders, as is frequently the case, the first mortgage lender who might otherwise be inclined to modify the contract so the borrower can afford it won’t do it unless the second mortgage lender also makes a concession. This so complicates the process that it may not get done, leaving the borrower with no place to go — except to foreclosure.


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