Silent Second Mortgage: What You Need To Know
Victoria Araj4-minute read
September 16, 2022
When you take out a loan (in addition to a mortgage) in order to make a down payment, it’s called a silent second mortgage. And while a silent second mortgage may sound like a nice deal, there is a right and a wrong way to do it.
Below is a primer on silent second mortgages, the risks, pitfalls and how to legally take out a second mortgage on a property should you need money for the down payment.
What Is A Silent Second Mortgage?
A mortgage is a loan used to purchase a residence or piece of real estate. When a borrower takes on their first mortgage to buy a home, they get the money, but they also use the home as collateral to secure the loan.
A second mortgage is an additional mortgage on one piece of property. It is considered “silent” if that second mortgage or loan is used to secure down payment funds and then not disclosed to the original mortgage lender prior to closing. Failing to disclose a second loan to a lender is very illegal, and borrowers who fail to do so could be prosecuted.
How Do Silent Second Mortgages Work?
So, if they’re illegal, how do silent second mortgages work anyway? Second mortgages themselves are perfectly commonplace and legal, but it’s when borrowers try to hide loans taken out on a property that the legal boundaries get crossed. Even if you think this isn’t such a big deal, remember that lenders require borrowers to document where any down payment funds came from, so not disclosing a second mortgage (or blatantly lying about where the money came from) makes this practice illegal.
Silent second mortgages exist in the first place because borrowers often need funds to afford the down payment on a home. For example, Davis wants to buy a home for $200,000 but lacks the $40,000 needed for the 20% down payment. He doesn’t want to lose out on the home, so he takes out a loan from a private investor so it won’t appear on his credit report.
The bank has no idea he didn’t use his own money for the down payment, which makes this loan between Davis and the private investor a silent second mortgage, and because it wasn’t disclosed, it’s an illegal practice.
Why Are Silent Second Mortgages A Risk For Lenders?
During an expensive home purchase, the object being bought (the house) is the collateral. So, if another loan exists on the collateral, there will be a problem for the first lender, especially if they need to seize the home in the event of foreclosure. They can’t take clear ownership of the home during the foreclosure process if there are other outstanding liens on the property.
Disregarding the legal aspect, even though buying a house with no money down sounds like a great opportunity, a silent second mortgage is bad news for homeowners too. With a second mortgage, a buyer is always taking on more debt, often at a higher interest rate than what comes with low mortgage rates, plus they end up paying more in interest over time and having two separate monthly payments.
Not to mention, with no real money down, a buyer will have to wait longer to earn true equity in the home.
How Can I Avoid A Silent Second Loan With A Down Payment Assistance Program?
There’s good news for borrowers who need money for a down payment (and this option is perfectly legal). Borrowers can avoid silent second mortgages by applying for a down payment assistance (DPA) program.
Currently, there are several down payment assistance programs available through both local and state governments, as well as at the federal level. If approved, these programs do create a second mortgage on the home, but the lender knows about them and often works with these programs to incentivize buyers toward homeownership.
By pairing a first-time home buyer program with down payment assistance, you can skip the need for a silent second mortgage loan. For instance, let’s say you purchase a home through the Fannie Mae HomePath loan program. You would only need 3% for a down payment, so you could apply for a local or state grant that would cover the remaining balance. Or, if you use an FHA loan, your lender can help you find an assistance program that works for your situation.
Here's more information on down payment assistance accepted by Rocket Mortgage®.
How Do Down Payment Assistance Loans Work?
In order to receive down payment assistance, potential borrowers must meet certain program criteria that are often based on income, occupation and credit score, although the eligibility requirements and amount of assistance offered varies by state and program. But in a broad sense, here is how down payment assistance loans work:
1. The borrower receives a flat amount or a certain percentage of the purchase price in assistance.
2. In exchange for money at closing, the program creates a “soft” second mortgage on the property. The term “soft” is used because the loan terms are incredibly favorable to borrowers; in other words, sub-market interest rates, lenient loan terms and even full forgiveness in some instances.
For example, Sadie applies and is approved for a down payment assistance program in Atlanta. She receives $15,000 to help with her down payment and closing costs and in exchange, a soft second mortgage is placed on her home.
The terms of her second loan are that $3,000 is forgiven each year. If she stays in her home for 5 years, the loan is forgiven in its entirety, or if she sells before year 5, she will have to pay back the amount left on this second mortgage. The program is designed to stabilize neighborhoods hit hard by the 2008 foreclosure crisis, allowing people to buy these vacant houses and stay in them long-term.
If you receive a down payment assistance grant (as opposed to a loan), well, that’s great! Free money! Sometimes these grants are also referred to as silent or “soft” second mortgages, but lenders also know about these, so they are not the illegal kind.
Loans forgiven over time and with 0% interest loans are available through the down payment assistance programs, but you won’t know what you qualify for (or even what’s available) without doing a little research or contacting your local Department of Housing and Urban Development (HUD) office.
The Bottom Line
Lying about your down payment funding is mortgage fraud. Committing mortgage fraud via a silent second mortgage could result in defaulting on your home at best and jail time at the worst. Instead, if you are struggling to come up with a down payment, you should look into “soft” second mortgages offered through down payment assistance programs sponsored by local government agencies and HUD.
While the amount of assistance offered varies by program, buyers shouldn’t let a lack of a down payment keep them from achieving homeownership. Learn more by reading about the options available to you for getting a house with no money down.
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