What is a Combination Loan?

A combination loan comprises two different mortgage loans from the same lender, to the same borrower. A combination loan type provides funding for building a new home, alongside a conventional mortgage upon successful completion. Another combination loan type provides two simultaneous loans for buying an existing home. It is often utilized when the buyer cannot raise a 20% down payment but doesn't want to pay for private mortgage insurance (PMI).

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How Does a Combination Loan Work?

For a new home, a combination loan typically comprises a mortgage with an adjustable rate to finance the construction, then another loan, usually a 30-year mortgage, upon the completion of the home. Usually, the second loan would be used for paying off the first, thus leaving the borrower with a single loan. For someone purchasing an existing home, a combination loan might take the form of either an 80-10-10 or piggyback mortgage. An 80-10-10 mortgage comprises two loans with a down payment. The primary loan encompasses 80% of the purchase price of the home, the second, another 10%, and then the buyer makes a cash down payment of 10%. Because the primary loan has a loan-to-value ratio of 80%, the buyer can always avoid paying for private mortgage insurance (PMI), which is usually needed when homebuyers make down payments lower than 20%. PMI is not a one-time expense but has to be paid yearly until the equity of the homeowner gets to 20%. It usually costs borrowers an amount equaling between 0.5% and 1% of their loan's value yearly. The second loan accounts for the remaining 20% down payment. It would always take the format of a home equity line of credit (HELOC). A HELOC works similarly to a credit card, but it has a lower interest rate since it's backed by the equity in the home. Thus, incurring interest only when the borrower makes use of it. [Important: A combination loan is capable of helping home buyers prevent the extra cost of private mortgage insurance.]

Pros and Cons of a Combination Loan

Making use of a combination loan to purchase an existing home is likely to be popular in active housing markets. As prices go up and homes become more expensive, piggyback mortgages allow buyers to borrow more funds than their down payment may permit. This can be advantageous provided buyers do not amass more debt than they can pay should something go wrong. Combination loans can be an option for those planning on purchasing a new home but have not sold off their current home yet. In that case, the buyer could utilize the HELOC to cover part of the down payment on the new home and eventually pay off the HELOC once the old home sells. Buyers constructing a new house might have better or less costly options than a combination loan. For instance, the builder may fund the construction. Then, upon the successful completion of the home, the buyer can get a regular mortgage and pay the builder. On the other hand, the homeowner may utilize a stand-alone construction and shop for a mortgage that's permanent. However, a combination loan might be more advantageous than two different loans from various lenders, because of its closing costs that are one-time.