What is a Tandem Loan
A tandem loan refers to a pair of loans taken out on a single asset.
BREAKING DOWN Tandem Loan
Tandem loans typically get attached to large assets, including single-family homes or commercial real estate that uses multiple sources of funding in the course of the asset's life. Tandem loans can make financial sense in cases where a single loan equal in size to the tandem loan would generate additional fees or expenses. For example, a home buyer might take out a loan to make a down payment for a mortgage in order to reduce closing costs or to avoid mortgage insurance required for down payments under a certain percentage of the home's value. Alternatively, if the amount a prospective buyer must finance to purchase a loan exceeds the amount available via a conventional loan, the borrower might use tandem loans to avoid the expenses associated with a jumbo loan. In this case, the borrower could take out a conventional mortgage for the highest eligible amount and then finance the remainder of the purchase with a second loan.
Example of Tandem Loans
Suppose a home buyer wanted to purchase a home with a 10 percent down payment. The lender requires private mortgage insurance for loans when the borrower has less than 20 percent equity in the home, which raises the borrower's monthly payment. The borrower may eventually have to get an appraisal of the home to demonstrate a 20 percent equity stake after several years of principal payments, a rise in home values in the area, or a combination of the two. In order to avoid the expenses related to all of this, the borrower simply decides to take out a second loan in tandem with the first, covering the remaining 10 percent of the down payment. The 10 percent down payment plus the proceeds from the second loan provide a down payment for the first loan, relieving the borrower of the mortgage insurance requirement and its associated payments.
Borrowers interested in tandem loans need to make careful calculations to ensure that the added closing costs and the total cost of borrowing for the tandem loans represents substantial savings over any other alternative.
Tandem Loan Compared to Tandem Plan
Borrowers should take care not to confuse tandem loans with a tandem plan, which allowed the Government National Mortgage Association (GNMA), also known as Ginnie Mae, to purchase mortgages for non-profit public housing at discounted prices. Ginnie Mae could then resell the mortgages through Fannie Mae and Freddie Mac, effectively subsidizing low-interest-rate loans for home buyers who would not otherwise be able to afford them.