Mortgage Combos and Blended Rates

Quite often, borrowers will need to take out two loans simultaneously to finance their home purchase or refinance. And the way you structure your loans could save you a ton of money on your mortgage payment every month.

Most banks and mortgage lenders only allow loan-to-value ratios (LTVs) of up to 80% because loan amounts exceeding 80% LTV aren’t eligible to be purchased or securitized by Fannie Mae and Freddie Mac, which makes them less liquid on the secondary market. This is important, seeing that most banks quickly sell off their loans shortly after origination.

Additionally, loans with a LTV ratio greater than 80% typically require Private Mortgage Insurance (PMI), making them a more expensive option than loans kept at or below 80%.

Fortunately, homeowners can avoid costly PMI by keeping their first loan at 80% LTV or less, and adding a second mortgage up to 100% combined loan-to-value (CLTV), assuming a lender allows it.

If a homeowner breaks up their mortgage into two separate loans, even with two separate banks, they can avoid paying PMI. On top of that, they can also enjoy a lower blended rate than simply going with one loan at say 90-100% CLTV. It has become a popular practice, and every homeowner should know how to figure out blended rates before even thinking about a combo loan.

One mortgage at 90% LTV:

Purchase price: $500,000
Loan amount: $450,000 @8%
*You also need to pay PMI

Two mortgages at 90% CLTV:

Purchase price: $500,000
First mortgage: $400,000 @6.5%
Second mortgage: $50,000 @9%
Blended rate: 6.778%

Hypothetically speaking, a borrower could finance one loan at 90% LTV at an interest rate of 8% and pay PMI. Or the borrower could take out a first mortgage for $400,000 at 80% LTV at a rate of 6.5%, and a “piggyback” second mortgage for the remaining $50,000 at 90% CLTV at a rate of 9%.

If we blend the two mortgage rates together, we come up with a combined rate of 6.778%. This is a considerable savings compared to 8% for a single loan that also requires PMI. Sure, there are fees for a second mortgage that need to be considered, but those should be easily eclipsed when the difference in interest rate is so substantial.

Sometimes a blended rate is a necessity, and sometimes a blended rate is a cost-saving measure. Some banks and lenders don’t allow LTVs over 80%, so anyone financing more than 80% LTV will need to take out two loans.

In another example, a borrower may choose to break up an 80% LTV loan into a 65% first mortgage and a 15% second mortgage just for the sake of securing a much better interest rate on the first.

Finally, a borrower may consider a combo loan to avoid taking out a jumbo loan. If your single loan exceeds the conforming loan limit, it will receive jumbo loan pricing, which is typically higher than what’s offered for a conforming loan. By breaking up a loan in two, you can keep the first under the conforming limit, and enjoy a lower interest rate.

[Jumbo vs. conforming loans]

Always refer to the blended interest rate to see how much it may save you on your overall mortgage payment. It’d be silly not to take some time out of your day to look at all the possible scenarios.

Keep in mind that second mortgages are often more expensive than first mortgages, but because of the smaller loan amounts, you’ll be able to pay them off quickly and save money in the long run.

Take action: Feel free to use my one of my Excel-based calculators to see if two mortgages are cheaper than one.  You can download my Blended Rate Mortgage Calculator for free by clicking the link.


3 Comments

  1. Darin June 26, 2014 at 12:17 am -

    One issue with combos is that you have to worry about getting two lenders to approve your loan, which can obviously complicate matters. Make sure the savings warrant the extra hassle.

  2. Beverly September 6, 2016 at 1:22 am -

    My second mortgage was sold and bought. New owners are evicting me however the first mortgage is in my name. Two deeds 20% second mortgages 80% first mortgage. The new owner paid $26 for the second mortgage asking $45 to get deed back. Do I have any options?

  3. Colin Robertson September 8, 2016 at 9:11 am -

    Beverly,

    Might be a question for a real estate attorney and/or the loan servicers involved.

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