While rising interest rates have sharply reduced the number of mortgage borrowers who can refinance into a lower rate, rising home prices create opportunities for some borrowers to refinance into mortgages that are less costly in other respects.
One possibility, discussed in a previous column, is to refinance a mortgage carrying mortgage insurance into one that doesn't require mortgage insurance.
Another possibility, the subject of this column, is to refinance a piggyback -- a combination of a first and a (more costly) second mortgage -- into a solo first mortgage.
Piggybacks that combined a first mortgage equal to 80 percent of property value with a second mortgage of 5, 10, 15 or 20 percent of value grew rapidly during the years preceding the financial crisis. The major attraction to borrowers was that the monthly payment on the second mortgage was less than the alternative monthly mortgage insurance premium.
The lower payments on piggybacks reflected their modest interest rates -- lenders under-estimated default risk because of the high rate of house price appreciation. A widespread practice, furthermore, was to make the payment of the second mortgage interest only for the first 10 years. In some cases, the second mortgage was an adjustable-rate line of credit, called a HELOC, with low initial rates but high potential for future rate increases.
The crisis shake-out
The decline in house values associated with the financial crisis was the largest and most widespread decline since the 1930s. Many of the borrowers with piggyback loans found that the equity in their homes was negative, and the default rate on second mortgages soared.
While investors in second mortgages that had little or no equity protecting them had little incentive to foreclose, borrowers remained liable. The second mortgage lender could prevent the borrower from selling the house or modifying the terms of their first mortgage. Many borrowers discovered the hard way that when things go wrong, it is better to have mortgage insurance than a second mortgage.
Yet many piggyback borrowers survived the crisis unscathed. They did not default or tarnish their credit, and their homes are in areas where house prices have fully recovered. These borrowers could benefit from refinancing today.
The refinancing option for piggyback survivors