Signs of lenders tightening credit standards and flight to quality in a time of uncertainty
At a time when record-low interest rates prompted home-buying frenzies, surging property values and mortgage lending, piggyback financing – once a popular means of homeownership financing back in the last housing boom – has missed out in the current pandemic housing boom.
A piggyback loan is incurred when a homebuyer takes out a second mortgage concurrently with the first mortgage on the property. For a prospective borrower making less than 20% down payment, the borrower may find it less expensive to take out a piggyback loan to cover any shortfall in down payment than paying primate mortgage insurance (PMI). A loan typically structured as down payment towards the home – thus allowing homebuyers to borrow a higher percentage of the home’s value – piggybacks can be particularly helpful to buyers who have no or limited savings.
At the height of the pandemic housing boom, piggyback lending contracted and treaded mostly in the negative growth territory.
Figure1: Year-Over-Year Change in Piggybacked First Mortgages (in loan volume)
In Figure 1, the year-over-year (YoY) change in piggybacked first mortgages (in loan volume) is stacked against the YoY change in the total number of mortgaged home purchases (solid line) and total home purchases (dashed line) which also include homes purchased with a mortgage.
From July 2020 to June 2021, after the initial pandemic shock to the economy, the broad housing market recovered quickly and was going from strength to strength as seen in fast-accelerating YoY home sale growth. But the growth was notably absent for piggyback lending despite a time of potentially greater demand from cash-strapped homebuyers amid high home prices. During this 12-month period, the number of piggybacked first mortgages declined 3.5% YoY while first-lien purchase mortgages jumped 19%. Prior to the COVID-19 pandemic, the growth trend in piggyback lending was robust and generally outpaced the growth of home financing.
When the home-buying frenzy finally fizzled out in summer of 2021, the pandemic contraction in piggyback lending further deepened. In the months from July 2021 to June 2022, the decline in piggybacked first mortgages accelerated quickly and far outpaced the decline in the volume of first-lien purchase mortgages as interest rates began to climb. The 12-month loan volume in piggybacked first mortgages fell another 17.0% from the same period a year ago, compared to a 11.5% decline in the number of home-purchase mortgage origination.
Figure 2 further reveals that piggyback lending has dropped to an all-time low following the pandemic. In Q2 of 2022, slightly over 3% of first-lien purchase mortgages incurred a concurrent piggyback loan, down from close to 5% just before the onset of the pandemic. While fewer borrowers used a piggyback loan, fast-rising home prices have led to a larger piggyback loan size. In June 2022, the median loan amount reached $12,500, up 12.5% YoY from $11,000 in June 2021.
Figure 2: Piggyback Lending at an All-Time Low Despite the Pandemic Housing Boom
Figure 3 breaks down the share of piggyback lending by different loan types. Notably, the share of piggyback lending to lower risk borrowers such as jumbo borrowers has increased sharply during the pandemic. In January/February 2020, piggybacked jumbo loans made up about 4.5% of all piggybacked purchase mortgages. By December 2021, its share has increased to above 8%. It continues to hover at about 8% in Q2 of 2022.
Figure 3: Flight to Quality – Rising Jumbo Share and Declining FHA Share Amid Piggyback Lending Contraction
Entering 2020 and just before the pandemic, piggybacked FHA loans accounted for about 53% of all piggybacked purchase mortgages. In June 2022, the FHA share is down to 42.5%. The share of piggybacked conventional loans declined slightly early in the pandemic, from 43% in January 2020 to 40% in January 2021, but has since redounded. In June 2022, the conventional share was about 49.6%.
While lenders tightened credit standards in response to the pandemic, the loan-to-value ratio of the piggyback loan amount as a percentage of a home’s sale price indicates that credit availability to those who were approved the loans was not at all inhibited. Figure 4 provides the piggyback loan-to-value ratio for each loan type. Through the pandemic, the piggyback loan-to-value ratio has remained either unchanged at times or increased. As of June 2022, median conventional piggyback loan-to-value ratio has risen to 9.8% and jumbo to 13.1%; before the pandemic, median piggyback loan-to value ratio was slightly above 6% for conventional loans and 12.5% for jumbo loans. The FHA piggyback loan-to-value ratio remains largely unaffected at about 4%.
Figure 4: Flight to Quality – Piggyback Loan-to-Value Ratios are up Through the Pandemic
In summary, piggyback lending contracted during the pandemic. The pandemic housing boom and fast-appreciating home value mean that the demand for piggyback loans to help finance home purchase is potentially strong. However, the pandemic has made it more challenging for lenders to assess borrower credit quality. In addition, the pandemic has also created more uncertainty surrounding the near-term risk.
Lenders have responded to the uncertainty by tightening access to credit by borrowers with marginal credit while also shifting credit availability to high-credit borrowers. Amid a contraction in the overall piggyback lending activity, lenders also increased credit flow to jumbo borrowers and tightened credit to FHA borrowers. Such a shift and flight to quality is also seen in rising piggyback loan-to-value ratio to those approved of credit.
 The annual cost of PMI varies widely depending on a borrower’s FICO score and can range from as low as a quarter of a percentage point to several percentage points. Thus, whether the overall mortgage cost is cheaper with a piggyback loan or with paying PMI also depends importantly on the borrower credit quality.
 A 2018 Urban Institute study finds that down payment affordability is the number one barrier to the homeownership acquisition: https://www.urban.org/sites/default/files/publication/99028/barriers_to_accessing_homeownership_2018_4.pdf
 Most measures of borrower credit quality during the pandemic have indicated tightened credit standards but increased credit availability to borrowers with more pristine credit. See, example, “Residential Lending During the Pandemic,” FDIC Quarterly, Vol 15, 2021. https://www.fdic.gov/analysis/quarterly-banking-profile/fdic-quarterly/2021-vol15-2/article2.pdf