What Is a Combination Mortgage?

Combination loans can save you money, or be double trouble. Lenders alter, add and withdraw the loan products they offer depending on consumer demand, the financial climate and sometimes, creative thinking. Combination loans might be what you need if you don't have a large down payment saved up, can't access liquid funds at the time of your purchase, or you need a large loan.

In a typical combination loan, you apply for and get two loans, rather than one, ideally from same lender. The first loan provides funds for the larger percentage or the total amount of money you need. In 80/20 loans, you obtain 80 percent from the first loan and 20 percent from the second, for 100-percent financing of a home. You pay 5 percent down for an 80/15/5 loan and fund the rest divided between an 80 percent first and a 15 percent second mortgage.

Typically, the first loan has the lower interest rate and is a fixed-rate loan – if your credit scores qualify you for one. The second loan has a higher interest rate or a variable rate.

Another type of combination mortgage pairs a construction loan with a purchase loan. The construction loan pays for building the new home, and the purchase loan is the conventional mortgage on the home. The construction loan may be structured as an adjustable-rate mortgage (ARM), and the second loan may be conventionally structured as, for example, a 30-year fixed-rate mortgage. In some cases, the combination loan is structured so that the second loan actually pays off the first loan.

Dividing a 100-percent loan into two avoids your having to pay mortgage insurance. Lenders require mortgage insurance when you finance more than 80 percent of the home's value. You save by not paying for the premium, and you save on closing costs when the two loans go through the same lender and close at the same time. You also benefit from combination loans when your loan amount exceeds the limit for conforming loans.

As of 2019, the cut-off for a conventional mortgage is $484,350 for the contiguous states, District of Columbia, and Puerto Rico; and $726,525 for Alaska, Hawaii, Guam and the U.S. Virgin Islands. For designated high-cost regions, the maximum conventional loan is $726,525 for the contiguous states and District of Columbia, as detailed on the Fannie Mae website.

You divide up the loan so that the larger amount stays under the limit, and obtain the lower conforming interest rate for the first loan. Hopefully, you pay off the second higher-rate loan over a short term.

The combination loan sometimes consists of a conventional mortgage combined with a home equity line of credit. Homeowners take advantage of this loan when they obtain their original mortgages, and want credit right away. The loans mean you owe more money on the home every time you spend money from the line of credit.

Two loans are better than one, only if the terms of each are beneficial. Check your loan disclosure statements and look for prepayment penalties imposed on early pay offs. Ask about how much your interest rate could rise in variable-rate loans before any caps on the rates stop increases. Watch out for interest-only second mortgages, in which you make monthly payments, but might make no headway on paying down the principal on the loan.