What is a Combination Loan
A combination loan consists of two separate mortgage loans by the same lender, for the same borrower. One type of combination loan provides funding for the construction of a new home, followed later by a conventional mortgage after the building the house is complete. A separate type of combination loan provides two simultaneous loans for the purchase of an existing home, usually when the buyer has a small down payment and seeks to avoid paying private mortgage insurance (PMI).
BREAKING DOWN Combination Loan
When building a home, combination loans can finance the construction and is generally distinct from a long-term mortgage. With a combination loan, the first loan is usually an adjustable-rate mortgage. Upon completion of the work, that loan is repaid by a second loan, typically a 30-year mortgage on the home.
For buying an existing home, simultaneous combination loans act as a piggyback or an 80-10-10 mortgage. The first mortgage will have an 80-percent loan-to-value ratio, the second mortgage has a 10-percent loan-to-value ratio, and the borrower makes a 10-percent down payment. Many times, an 80-10-10 loan will help purchase and renovate the existing structure. The renovations will increase the value of the home which, when added to the 10-percent down payment usually helps the buyer avoid paying private mortgage insurance (PMI). PMI is typically necessary with down payments under 20 percent.
One of Several Ways to Finance Building a Home
Consumers have options other than a combination loan in the construction of a home as their permanent residence. For example, the builder might finance the construction. Then, when the house is complete, the buyer arranges a mortgage and pays the builder. Alternatively, the homeowner might use a stand-alone construction loan. Upon completion of the construction, the buyer may shop for a permanent mortgage. The primary advantage of a combination loan can be one-time closing costs. The disadvantage is the buyer must secure both loans from a single lender.
A Home Equity Loan as a Down Payment
The second mortgage in a combination loan is usually a home equity line of credit (HELOC). This note functions much like a credit card, but with a lower interest rate since the equity in your home backs it. As such, it only incurs interest when you use it. That means you can pay off the HELOC and eliminate those payments. Moreover, once paid, the HELOC line of credit remains for use with other expenses, such as ongoing maintenance, emergency use, or education expenses.
Piggyback mortgages tend to be popular in active housing markets. As prices climb and homes become less affordable, piggyback mortgages allow buyers to borrow more money than their down payment might suggest. They are also a good option for people trying to buy a new home, but who have not yet sold their existing home. In that scenario, the buyer could use the HELOC to cover a portion of the down payment on the new home and pay off the HELOC when the old house sells.