A combo loan is a form of mortgage loan involving a combination of two loans against one asset, most commonly a house. The combo loan was created to eliminate the borrowers' need for private mortgage insurance when financing more than 80 percent of the home's value.
Lenders require mortgage insurance to protect their investment on mortgages issued with little or no down payment. If the borrower defaults on the mortgage, the mortgage insurance company comes in to reimburse the lender. Mortgage insurance is not free, however, and the borrower must make monthly premium payments to the mortgage insurance company despite the fact that the insurance protects lenders and not homeowners.
A combo loan is a method for getting around mortgage insurance requirements. This is because combo loans divide a mortgage into two loans: one to pay the down payment and another, more typical mortgage. In this way, borrowers work around the 20 percent down payment requirement needed to forgo mortgage insurance. While this method can help homeowners obtain a loan without a down payment, it should be noted that this loan structure does not offer default risk that is less than that of a traditional mortgage with no down payment.