Piggy Back Lending: Off the Charts

Piggy-back loans (second lien) were one of the emblems of the go-go days of subprime lending.  Lenders took the risk, perhaps because buyers of mortgage-backed securities had the appetite, to make loans that were vulnerable to default. The results were ruinous.  No one planned for 11 percent unemployment.  No one planned for a time when home values would drop by more than 40 percent in one year.

“Piggy-backs” (also called “80-10-10s”) played a big role in the end of a number of lenders: Washington Mutual, ownit.com,and E-Trade are among some of the institutions felled by these loans.

It should have been a warning to regulators that people were choosing to substitute a payment to a private mortgage insurer with new debt on a second mortgage. Here is a link to a “mortgage advisor” who suggest that borrowers use the piggy back product to finance 103 percent.

Volume and pricing on "Piggy-Back" loans, 2004-08.

What made these loans especially problematic was the way that they turned up the pressure on a borrower’s debt service.  With a piggyback, a borrower didn’t just have more debt to service. He or she also had more debt that was more expensive.  It wasn’t unusual for a piggyback to require a 150 basis point premium to the pricing on the first.

Now that homes are entering foreclosure, these loans are the first to fall.  In a foreclosure, most of these are virtually worthless.

There are two periods that are particularly interesting in this chart.  First, it shows that the peak for this kind of audacious lending was from 2005 to 2006.  In each of these years, lenders made more than 1.3 million second position loans on home purchases.

Then, there is 2008, where it shows that lenders turned off the spigot.  This is good news.  The market is correcting itself.  Note that the market didn’t gauge this risk correctly – it took a major financial disaster for buyers and sellers to come to the truth that these were bad products.  Moreover, there is probably more trouble ahead – even now, more mortgages are resetting.  In states like Delaware and Maryland, more than 10 percent of all subprime loans are still yet to reset, but are due to do so in just the next twelve months.

Going forward, I wonder what impact this will have on future demand for new housing.