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Piggy-Backs Compete With Jumbo Loans

Although most home buyers aren't looking for a jumbo loan ($227,150 and up), jumbos are increasingly common in expensive real estate markets such as New York and Washington, DC or the highest-priced U.S. market, San Francisco, where the average home sells for over $300,000. But they're not cheap. Interest rates on jumbos have gone up recently, says Lew Sichelman, so much so that taking out two conforming-size loans can be cheaper than one jumbo.

To understand the economics, home buyers must first understand the difference between conforming and jumbo. Conforming loans are sold to the two major secondary mortgage firms, Fannie Mae and Freddie Mac. The maximum size is $227,150. Bigger loans (jumbos) are more expensive because they are more difficult to sell on the secondary market. That is why loan providers charge a higher interest rate for jumbo loans, up to 3/4 percent higher in recent weeks.

Recent hikes in jumbo rates, caused by turmoil in the capital markets, have put the pinch on high-end home buyers looking for ways to economize. Some are just waiting it out until rates stabilize. But where there's a will there's a way, and one way is to take out two loans: a first for $227,150 and a second "piggy-back" loan for the balance. Where's the catch? Second loans are more expensive because they entail higher risk to the loan provider. (In the event of a loan default, the second lien holder has to wait in line behind the first loan provider to get paid, if anything's left.)

But as long as the difference in rates between the first and second loan is not that great, it's cheaper than taking out one jumbo loan. Whether you qualify for a decent rate on the piggy-back loan actually depends on your credit and available cash for a down payment. In addition, the lender will look at the Loan-to-Value ratio. If these factors line up in your favor, it's worth the time pursuing the piggy-back option with the right loan provider.

Consider the following scenario on a $300,000 house with 20 percent down. At 7.5 percent, monthly principal and interest would be $1,678.11 on a jumbo loan. On two conforming loans, the numbers might look like this: a first loan for $227,150 at 6.75 percent, and a home-equity line of credit for the $12,850 balance at 9.875 percent. That works out to a net savings of $99.08 per month, or almost $1,200 per year. Not bad. Of course, always remember to ask for a written interest rate lock-in, and specific disclosure of fees and points.