Combination Loan Definition

When buying a home, it's typical to shop for a single mortgage product. In some cases, however, it may be necessary to get a combination loan or combination mortgage instead. This type of loan is also sometimes referred to as a piggyback mortgage, depending on its use. Not all mortgage lenders offer combination loans, and there are some pros and cons involved when taking one out to purchase or build a home.

Key Takeaways

  • A combination loan is two separate mortgage loans granted by the same lender to the same borrower.
  • Combination loans can fund the construction of a new home or purchase an existing property.
  • Choosing a combination loan may allow borrowers to avoid paying private mortgage insurance (PMI).
  • Taking out a combination loan could increase costs in terms of interest and fees, and it also means juggling two mortgage payments.

What Is a Combination Loan?

A combination loan consists of two separate mortgage loans granted by the same lender to the same borrower. One type of combination loan provides funding for the construction of a new home, followed by a conventional mortgage after the construction is complete. Another type of combination loan provides two simultaneous loans for the purchase of an existing home. It's often taken out when the buyer can't come up with a 20% down payment but wants to avoid paying for private mortgage insurance (PMI).

Note

Private mortgage insurance applies to conventional loans, though some government-backed loans may have their own mortgage insurance requirements.

How a Combination Loan Works

In the case of a new home, a combination loan usually consists of an adjustable-rate mortgage to finance the construction, followed by a second loan, typically a 30-year mortgage, when the home is finished. Typically, the second loan will pay off the first one, leaving the borrower with just a single loan.

For someone buying an existing home, a combination loan may take the form of a piggyback or 80-10-10 mortgage. An 80-10-10 mortgage consists of two loans with one down payment. The primary loan covers 80% of the home's purchase price, the second loan another 10%, and the buyer makes a 10% cash down payment.

Because the primary loan has an 80% loan-to-value ratio, the buyer can usually avoid paying for private mortgage insurance (PMI), which is generally required when homebuyers make down payments of less than 20%. PMI isn't a one-time expense but must be paid annually until the homeowner's equity reaches 20%. It generally costs borrowers an amount equal to 0.5% to 1% of their loan's value each year.

The second loan accounts for the rest of that 20% down payment. It will usually come in the form of a home equity line of credit (HELOC). A HELOC functions much like a credit card, but with a lower interest rate because the equity in the home backs it. As such, it incurs interest only when the borrower uses it.

A combination loan can help homebuyers avoid the added cost of private mortgage insurance, but HELOCs may come with variable (rather than fixed) interest rates.

Pros and Cons of a Combination Loan

Taking out a combination loan to buy an existing home tends to be most common in active housing markets. As prices climb and homes become less affordable, piggyback mortgages let buyers borrow more money than their down payment might otherwise allow. That can be an advantage as long as buyers don't take on more debt than they can handle should something go wrong.

Combination loans can also be an option for people who are trying to buy a new home but haven't sold their current one yet. In that scenario, the buyer could use the HELOC to cover a portion of the down payment on the new home and then pay off the HELOC when the old house sells.

Buyers who are constructing a new home may have simpler or less expensive options than a combination loan. For example, the builder might finance the construction. Then, when the home is complete, the buyer can arrange for a regular mortgage and pay the builder. Alternatively, the homeowner might use a stand-alone construction loan and then shop for a permanent mortgage.

However, a combination loan may have an edge over two separate loans from different lenders because of its one-time closing costs.

Alternatives to Combination Loans

Alternatives to combination loans include a range of mortgage products. For example, in place of a combination loan you might choose any of the following options for purchasing a home:

When comparing combination loan alternatives, it's important to consider how each type of loan works with regard to things like minimum credit score requirements, PMI requirements, debt-to-income ratio requirements, interest rates, down payments, and fees. In the case of FHA loans, for example, it's possible to borrow with as little as 3.5% down and a 580 credit score. On the other hand, USDA loans and VA loans require no down payment, but you may be subject to higher minimum credit score requirements, depending on which lender you choose.

Jumbo loans are mortgage loans that don't adhere to conforming loan limits. You may consider a jumbo loan if you're buying a more expensive home and aren't able to qualify for other loan options. Keep in mind that these loans may require larger down payments or higher credit scores to qualify.

Tip

Using a mortgage loan calculator can help you compare the cost of combination loans along with other options to help find the right one for your needs.

FAQs

What Is a Combination Loan?

A combination loan is actually two mortgage loans rolled into one. A combination loan can consist of a primary mortgage and a secondary mortgage, with each loan carrying its own specific repayment terms. A borrower who takes out a combination loan may have one or two mortgage payments, depending on how the loan is structured.

What Can Combination Loans Finance?

Combination loans can finance the construction of new homes. They can also finance the purchase of existing homes when the borrower wants to avoid paying private mortgage insurance. In this case, a combination loan or combo loan may be referred to as a piggyback loan or piggyback mortgage.

How Does a Combo Loan Work?

A combo loan works by allowing borrowers to take out two separate loans from the same lender for the same purpose. Each loan has set repayment terms, and the borrower is responsible for repaying both obligations. For example, a borrower may use the first loan to pay for the construction of a new home with a second loan term beginning when construction is complete.

Article Sources

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  1. Consumer Financial Protection Bureau. "What is a piggyback second mortgage?" Accessed Oct. 5, 2021.

  2. Consumer Financial Protection Bureau. "What Is Private Mortgage Insurance?" Accessed Oct. 5, 2021.

  3. Federal Trade Commission. "Home Equity Loans and Credit Lines." Accessed Oct. 5, 2021.

  4. Department of Housing and Urban Development. "Let FHA Loans Help You." Accessed Oct. 5, 2021.

  5. CFPB. "What is a jumbo loan?" Accessed Oct. 5, 2021.