What Is A Combination Mortgage?

*As of July 6, 2020, Rocket Mortgage is no longer accepting USDA loan applications.

A combination mortgage loan includes two separate loans for different purposes. Most people use combination loans when they want to buy a home but don’t have a 20% down payment. In this instance, you would take out one loan equal to up to 20% of the cost of your down payment first. Next, you’d take out another loan from the same lender equal to the remaining percentage of the loan value. This allows you to buy a home without paying for private mortgage insurance.

When Is A Combination Mortgage Beneficial?

A combination loan can offer you a few unique benefits when you buy a home – you can avoid PMI and also avoid getting a jumbo loan.

Avoid PMI

The main reason home shoppers get a combination loan is to avoid the PMI requirement on conventional loans. PMI is a type of insurance that you pay monthly if you have less than a 20% down payment when you buy your home. PMI protects your lender in the event that you default on your loan – and it doesn’t offer you any protection as the homeowner. However, your mortgage lender will still require you to pay a PMI premium every month if you finance more than 80% of your home's value.

PMI can add hundreds of dollars to your monthly mortgage payment, so some homeowners are willing to do anything they can to avoid it. When you take out a combination loan, you pay a fraction of your down payment in cash. The remaining loan brings your down payment up to 20% – the minimum threshold to avoid PMI. This type of loan can save you thousands if you can manage your payments and get a good interest rate.

Avoid Getting A Jumbo Loan

A jumbo loan is a very large loan that exceeds the limits of a conventional mortgage. Jumbo loans have much higher credit and debt requirements and are more difficult to qualify for. Some borrowers choose a combination loan if they’re a bit above the conventional loan limit. This can allow you to buy a larger home without meeting the stricter jumbo loan requirements.

Are There Drawbacks To A Combination Mortgage?

Combination mortgages aren’t for everyone. Let’s take a look at a few of the downsides to getting a combination mortgage.

• You’ll pay more in servicing fees. When you take on a combination loan, you take out two separate loans at once. This typically means that you need to pay twice as much in origination fees and any other servicing fees that your lender charges.
• You’ll need to manage two separate loan payments. Combination loans might come from a single lender but that doesn’t mean both loans have the same terms. You need to be able to manage two principal payments and two separate interest rates each month. If you fall behind on either payment, you run the risk of losing your home.
• A combination loan might end up costing you more money. The second mortgage in your combination loan usually has a higher interest rate than the first loan. You can cancel your PMI when you reach 20% equity in your home, but you cannot cancel your second mortgage until you pay it off. Depending on the size of your second mortgage, you might end up paying more for your combination loan than you would if you paid PMI for a few years.
• There are other ways to avoid PMI. A combination mortgage isn’t the only way that you can avoid paying PMI. Let’s say you qualify for a USDA or VA loan. You can buy a home with no money down and pay a small guarantee or funding fee instead of PMI. We’ll learn a little more about these loan types in the next section.

Alternatives To A Combination Mortgage

Consider one of these alternatives if you don’t think a combination loan is right for you. 

USDA And VA Loans

USDA loans are VA loans are two types of government-backed mortgages. This is a type of mortgage loan that has insurance from the federal government. These loans are less risky for lenders because they don’t need to worry about covering your payments if you default. A government-backed loan may be able to give you the funding you need if you don’t qualify for a conventional loan.

USDA loans are backed by the U.S. Department of Agriculture. They help those living in rural and suburban areas afford a home with lower financial requirements. VA loans are backed by the Department of Veterans Affairs. They’re intended to help service members and veterans afford property.

USDA loans and VA loans are both excellent alternatives to combination loans because they don’t require a down payment. You can finance 100% of your home’s purchase price without worrying about PMI. The catch is that you’ll need to meet a specific set of criteria before you qualify for a USDA or VA loan.

To qualify for a USDA loan, all of the following must be true:

• You generally must have a credit score of at least 640 points.
• You need to buy a home in an approved rural or suburban area. To see if your home qualifies, search for your address using the USDA’s property eligibility finder.
• Your annual income must be less than or equal to limitations set by the USDA. These limits vary by zip code, so be sure to check your income eligibility before you apply for a loan.

Rocket Mortgage doesn't currently offer USDA loans.

To qualify for a VA loan, you need to meet service requirements. Any of the following statements must be true:

• You’ve served 90 consecutive days of active service during wartime.
• You’ve served 181 consecutive days of active service during peacetime.
• You’ve been an active member of the National Guard or Reserves for 6 years or more. You can also meet service time requirements by serving at least 90 days under Title 32, provided at least 30 of those days are served consecutively.
• You are the surviving spouse of a service member who lost his or her life in the line of duty or as the result of a service-related injury.

Whether you get a USDA loan or a VA loan, your property needs to meet certain conditions to qualify as well. You can only buy a primary residence using either of these loans – you cannot finance an investment property or vacation home with your loan. Your home must also meet minimum livability standards. 

You must also pay a one-time funding fee or monthly guarantee fee, depending on the type of loan you choose. However, these fees are less expensive than PMI in most cases. You may also have the option to roll your fees into the principal balance of your loan. 

Conventional Loans

Conventional loans are the most common type of mortgage loan. You can get a conventional loan with as little as 3% down. Conventional mortgages also often have lower interest rates than comparable government-backed loans, which can save you money in the long run. You may need a conventional loan if you want to buy a more expensive property. Conventional loan limits are higher than government-backed loans.

You will need to pay PMI on your loan if you have a down payment of less than 20%. The good news is that you don’t need to pay PMI forever. Once you reach 20% equity in your home, you can contact your lender and request that they cancel PMI. If you don’t qualify for a USDA, VA or combination loan, the next best thing is usually a conventional mortgage. Keep track of your payments and request loan statements from your lender regularly so you know when you reach 20% equity. Most lenders will also automatically cancel your PMI when you reach 22% equity in your home. 

FHA Loans

FHA loans are another type of government-backed loan. You can get an FHA loan with as little as 3.5% down. FHA loans have looser credit and financial requirements compared to other types of loans. You can get an FHA loan with a credit score as low as 580. If you have at least 10% to put down on your home, you may qualify for a loan with a score as low as 500 points. You may even qualify for an FHA loan with a foreclosure or bankruptcy on your record if you’ve maintained a solid credit profile.

You don’t need to pay PMI with an FHA loan. However, you do need to pay a monthly mortgage insurance premium, which is included in your monthly payment. You’ll also need to pay an upfront MIP when you get your loan. Unlike PMI on conventional mortgages, you must pay MIP every month until you pay off your loan. Many FHA loan holders refinance their loan into a conventional mortgage once they reach 20% equity in their property. This allows you to save money by removing MIP and also avoiding the PMI requirement.

Summary

A combination mortgage is a type of loan that merges two loans together from a single lender. Most home buyers use a combination loan to fund their home purchase when they have less than 20% down. A combination loan can allow you to buy a home with a smaller down payment and can also help you avoid the private mortgage insurance requirement.

You’ll also be able to avoid the strict jumbo loan requirements if you’re a few thousand dollars over the conventional loan limit. Taking a combination loan also means managing two monthly mortgage payments. Depending on the amount you put down, you might end up paying more for a combination loan over time.

Combination loans aren’t the only way to avoid PMI. USDA and VA loans allow you to buy a home with no money down and pay a smaller guarantee or funding fee instead of PMI. If you do have a conventional mortgage, you can also ask your lender to cancel your PMI once you reach 20% equity. Check out our home buying and personal finance resource centers for other articles like this one.