Silent Second Mortgages: Benefits, Risks, & How They Work
Silent second mortgages are used when a buyer can't afford the down payment required by the first mortgage. The legal way to do it is by seeking government assistance; though that’s not always the case.
Silent second mortgages you shouldn’t use
If a home buyer secretly takes out a second loan from a different lender or a private investor to cover their down payment, it’s considered a silent second mortgage. This is because the existence of this loan is being kept hidden from the first lender, which is illegal. For the primary lender, it will look as if the borrower used his own money as an investment when it is actually borrowed.
Another variation is when the seller lends the buyer part or all of the money needed for the down payment, with the expectation it will be repaid over time. Though it may seem harmless, it’s still considered fraud because the lender is unaware that the purchaser is putting next to nothing down.
An even more severe deception arises when the silent second is used to inflate the sale price beyond the actual home value to increase the size of the first mortgage. Assume the buyer and seller agree to a price of $400,000, but the buyer has no down payment. The buyer and seller collude to set a fictitious price of $444,400, on the basis that the first mortgage lender agrees to lend $400,000. This is 90 percent of $444,400 but 100 percent of the true value of $400,000. The seller agrees to a second mortgage for $44,400 but forgives the second mortgage after the transaction is complete. This is fraudulent because the lender writes a 100 percent loan believing it’s a 90% loan. (Example is taken from The Mortgage Professor).
Risks of using these methods
If the hidden loan is noticed before (or even after) a first mortgage goes through, the borrower could be convicted of mortgage fraud. This could mean jail time up to 30 years, as well as fines. The bottom line — it’s not worth hiding behind a silent second mortgage from a private investor or home seller. Instead, you should look into legal silent second mortgages, like those listed below.
Silent seconds as down payment assistance (DPA)
When used as down payment assistance, second mortgages may carry a zero or low-interest rate; or interest may be deferred for a certain amount of time. This means that the borrower can focus their effort and resources in paying off the original loan first while the secondary loan remains silent.
Curious how much of a down payment you need? Read our article on down payment preferences and how they influence home cost.
Down payment assistance programs may be a challenge to find; however, there are over 2,000 programs across the United States. You’ll know your options are legal if they are offered by government-sponsored agencies, such as the Department of Housing and Urban Development (HUD).
Second mortgage examples that offer incredible benefits include:
The Chenoa Fund Program provides down payment assistance that’s up to 3.5% of the home’s purchase price. If you’re using a fixed-rate FHA first mortgage, that 3.5% down payment benefit covers the 3.5% down payment requirement of the FHA loan. If you’re using a conventional loan like Fannie Mae’s HomeReady loan, the 3.5% benefit can be applied toward closing costs and the 3% down payment requirement for 97% LTV conventional mortgage financing.
A “soft second” is a subordinate loan used to cover down payment and closing costs. The soft second has a deferred payment schedule, so borrowers do not have to make any payments until they sell their home or refinance. It’s an option that genuinely increases housing affordability because they do not add to the monthly costs of homeownership.
Better yet, many soft seconds are forgivable over a specified term, meaning if you stay in the home for a certain amount of time — you may not have to repay the soft second loan.
A silent second should not be confused with a "piggyback," which is also a second mortgage that replaces a down payment. The difference is that the piggyback is usually offered by the first mortgage lender, so no deception is involved.
It’s structured as an 80/10/10 loan where the first mortgage is written for 80% of the home purchase price. This loan is typically a conventional loan via Fannie Mae or Freddie Mac. The first “10” is a second mortgage that’s often in the form of a home equity loan or home equity line of credit (HELOC). The second “10” is the buyer’s down payment, which is paid in cash at closing.
They’re known as piggyback loans because the second loan “piggybacks” on the first loan to increase the total amount borrowed.
Using gift money
Maybe your best option is to forego a silent second or grant and to use money from a family member instead. The amount you’re eligible to receive depends on your loan program. There’s a good chance you may have to come up with your own money to help cover the cost of down payment, but your contribution won’t be nearly as much as a 10 or even 20% down payment.
How to sell a home with a second mortgage
Selling a property with a second mortgage isn't that much different than selling a property without one, but there are a few impacts you should prepare for.
If your second mortgage has a “due on sale” clause, expect to repay the loan immediately. The sale of the home cannot be completed if this doesn’t happen. That's because the second mortgage holder has the house as security for its loan and has a lien against the home.
Outside of a potential “due on sale” clause, the most significant impact a second mortgage has on the seller is the amount of profit they receive from the sale.
Tip: Make sure you understand any early payment penalties that might be triggered by the sale of your home.
Learn more about your options
Looking for an easy way to learn about down payment or silent second mortgage options? Let us help. You can schedule an appointment online or call us directly at (800) 910-4055. Our salary-based mortgage consultants can discuss loan programs and down payment assistance options that can get you into a home for less.