What Is a Silent Second Mortgage: Things You Need To Know

Article Summary:

It can be hard to save for a down payment. Some home buyers think a clever solution is to get a loan from a second lender to cover the down payment and not tell the first lender about it. This is called a “silent second mortgage.’ This article will tell you what you need to know about silent second mortgages, such as why they aren’t as clever as they sound and what are some better alternatives.

A silent second mortgage is a second or additional mortgage placed on a piece of real estate, typically a house, to fund the down payment required by the first mortgage lender. This, however, is not disclosed to the original lender. The second mortgage is called “silent” because the borrower does not disclose its existence to the original mortgage lender and the second lender does not record the associated lien until after the first mortgage has been approved and the home sale has gone through.

Silent mortgages are usually illegal

If you’re thinking this sounds unethical and possibly illegal, you’re right. Funding your down payment with a secret second loan against the same property puts you at risk of a fraud conviction. When mortgage lenders require a down payment, they aren’t looking for proof that you can get someone else to loan you money against the same home. And they won’t be pleased if they find out that’s what you’ve done. So don’t expect them to be supportive if you end up in court.

The FBI considers silent second mortgages a mortgage fraud scheme1. This is straight from the FBI’s website:

Silent second: The buyer of a property borrows the down payment from the seller through the issuance of a non-disclosed second mortgage. The primary lender believes the borrower has invested his own money in the down payment, when in fact, it is borrowed. The second mortgage may not be recorded to further conceal its status from the primary lender.

To protect yourself from doing something dangerous and unwise, you should learn about silent second mortgages, why you should avoid them, and how you can secure a second mortgage the legal way. This article will help you do that.

How does a silent second mortgage work?

Borrowers who take silent second mortgages usually do so to procure funds for a down payment on a home property. It allows them to purchase a home that they couldn’t afford, or to get better mortgage terms than they would otherwise.

Ideally, when a buyer purchases a home using a mortgage deal, the borrower is required to provide a down payment. Normally, the lender will also request that the borrower reveal all the sources of down payment funds. It is illegal to fund the down payment with a second mortgage unreported to the initial mortgage lender. (The first or initial mortgage lender is also known as the senior mortgage lender.) A borrower’s silence is deemed a lack of legally required transparency and disclosure.

For example, imagine you want to buy a home for $300,000. You’ve secured a mortgage of $300,000 that requires a 20% down payment of $60,000. You only have $10,000 in cash, but you don’t want to lose out on the home. So you take out a loan of $50,000 from a private lender, using the home you’re buying as collateral. Adding that to the $10,000 at hand, you make the $60,000 down payment. But, since this down payment comes with a $50,000 debt obligation against the property, it’s not really worth $60,000 to the first mortgage lender. By hiding the private loan, you’ve defrauded your first mortgage lender.

Note: Since laws vary around the world, you might discover that failing to disclose a second mortgage used for a down payment is legal somewhere. To err on the side of caution, however, this article will treat these arrangements as always illegal, and so best avoided.

Why are silent second mortgages a risk for lenders (like your mortgage lender)?

A silent second mortgage adds debt, and another outstanding lien, to the property. Should you default on your home loan, your first mortgage lender could run into problems when trying to foreclose.

This is why lenders are at risk when a borrower fulfills the down payment using a silent second mortgage. More debt owed and a second lender to pay off means trouble if a mortgage lender has to foreclose.

Mortgage lenders require a down payment to make a loan worth the amount of risk they think it involves. If you default and the lender has to go through the foreclosure process, the fact that you made a down payment of a certain size helps ensure they don’t lose money.

When borrowers use silent second mortgages to make down payments, lenders lose some of this protection. Recording the lien for the second loan right away would result in its showing up in a title search and being discovered by the first lender. That first lender could then reject your loan application or offer less appealing loan terms. For this reason, the liens for these hidden loans don’t get recorded until after the first mortgage goes through. Still, they do actually come first in time. Given this, are they really “second” mortgages? Is the “first” mortgage really first?

As you can imagine, lenders don’t want to have to deal with these kinds of lien-priority issues if they need to foreclose. Having to foreclose is a big enough hassle.

How can I avoid silent second mortgages?

If you need a legal way to fulfill your down payment without taking out a silent second mortgage, you should look into down payment assistance programs. There are many down payment assistance programs available. You can access them through local, state, and federal government agencies.

Loans obtained through these programs create a second mortgage on your new home, assuming you’re approved. What’s more, your primary mortgage lender is likely aware of these programs and has worked with them before to help borrowers obtain homes.

How do down payment assistance programs work?

Borrowers can access funds to fulfill down payment requirements using a down payment assistance loan or grant. The programs allow for legal disclosure to the lender of a first mortgage. There are over 2,000 down payment assistance programs across the United States.

These programs are funded and offered by such government agencies as the Department of Housing and Urban Development (HUD). These entities support down payment assistance programs as part of community development. Borrowers may be referred to a program by their loan officer. They can also research down payment assistance programs by contacting their local government housing agencies. For instance, HUD has numerous local offices across the United States.

The requirements for down payment assistance programs are slightly lower than the requirements for standard loans. The lending procedures are similar in that applicants are required to supply such personal information as income, occupation, and credit history.

Alternatives to silent second mortgages

In case you’re still tempted to take out a silent second mortgages and hope you don’t get caught, here are some alternatives to consider.

Piggyback loan

The piggyback is usually offered by your mortgage loan lender. So you’re not illegally hiding anything as with a silent second mortgage.

These are called piggyback loans because the second loan “piggybacks” on the first. This increases the total amount borrowed.

Gift Money

Another option is to use money given to you as a gift by a family member, or by someone else who’s especially generous. The amount of gift money you may use toward a down payment depends on your loan program.

In many cases, you will still have to come up with money of your own to cover part of the down payment, but your contribution could be considerably less than the 3% to 20% down payment you’d have to cover otherwise.

Could I use a personal loan for my down payment?

Personal loan can be a great source of funding for many things. For the most part, however, your home down payment is not one of these things. For instance, FHA and conventional home loans don’t allow using personal loans for your down payment.

If you want to try using a personal loan to cover your down payment, you need to disclose this to your lender. Concealing your source of funding could get you into trouble later, just like with a silent second mortgage.

That said, if you want to ask your mortgage lender if you can try this, feel free. A personal loan places an extra financial burden on you, increasing the possibility that you won’t be able to stay current with your mortgage payment. So, most likely, the home loans you’ll be able to get if you use a personal loan for your down payment will not be as good as what you could get otherwise.

All things considered, using a personal loan to fund your down payment will seldom be a good option. Hitting up your relatives and close friends for gifts and looking into down payment assistance programs are both likely to get you access to better mortgage terms.

Who benefits from a silent second?

Buyers who can’t afford the down payment required for a first mortgage sometimes resort to a silent second mortgage. Assuming the hidden loan against the property from a second lender doesn’t get discovered and the first mortgage and home purchase go through, the buyer who takes out a silent second mortgage benefits. The lender on the second loan may also benefit, since the ability to make a profit is why lenders make loans, after all. In fact, some lenders who provide silent second mortgages are private investors rather than traditional lenders.

Usage note: Watch out for misleading terminology

You may sometimes see a down payment assistance program identified as a legitimate form of “silent second mortgage.” Though we’ve seen this usage in some otherwise reputable sources, it’s very misleading. Down payment assistance programs are not hidden from mortgage lenders, so they aren’t “silent” in the way silent second mortgages are.

In this article, we refer only to the hidden, and so illegal, loans as silent second mortgages. Though these can benefit borrowers who don’t get caught, we judge them too risky and best avoided.

Do be aware, however, that even some generally trustworthy sources apply the term “silent second mortgage” to the loans buyers can acquire through down payment assistance programs — or to other loans that are not concealed from the senior mortgage lender. These loans are not silent in the sense used here. They may still be silent in the sense that their liens go unrecorded until after the first mortgage has gone through and had its lien recorded. In the case of these loans, however, there is no violation of disclosure requirements. No one is intentionally hiding anything from the senior lender.

How does a soft second mortgage work?

A soft second mortgage is a subordinate loan for covering down payment and closing costs. Down payments assistance loans are typically soft second mortgages.

The payment schedule for a soft second mortgage is deferred. This means borrowers do not have to make any payment until they sell or refinance their home. Since this does not add to the costs of homeownership, it increases the affordability of home real estate.

Also, many soft seconds are forgivable after a specified period. This means that if you stay in the home for a certain amount of time, you may not have to repay the soft second loan.

So, what are the benefits and drawbacks of a soft second mortgage or, for that matter, of any (legal) second mortgage? Let’s examine that question.

WEIGH THE RISKS AND BENEFITS

What are the pros and cons of a second mortgage? Here is a list of them to consider.

Pros of a second mortgage
  • Relatively high loan amounts. Lenders may allow you to borrow up to 90% of your home’s equity in a second mortgage. This means that you can get more money with a second mortgage than with other types of loans, especially if you’ve been making payments on your initial loan for a long time.
  • Lower interest rates than credit cards. They are secured debt since they have collateral behind them (your home). Lenders offer lower rates on second mortgages than on credit cards because the collateral makes it is less likely that they’ll lose money. Also, there are no special restrictions on how you can use the funds you get from a second mortgage. Once your loan’s been approved and you’ve received the money, you can spend it in any way can legally spend any of your income. You can use it for your wedding, to pay off college debt, or for whatever your heart desires.
Cons of a second mortgage
  • Higher interest rates than refinances. This is because secondary lien holders (i.e. lenders of second mortgages) have to wait in line behind the primary mortgage lenders to get paid in case of foreclosure.
  • May put some pressure on you financially. By taking out a second mortgage, you are saying you agree to make two monthly mortgage payments: one to your original lender and another to your latest lender. This can put a strain on your personal or household finances, especially if you’re already living paycheck to paycheck.
  • Added foreclosure risk. With the added financial pressure just mentioned comes added risk of foreclosure. Obviously, it is harder to remain current and avoid defaulting on two home loans than on just one. Any lender you borrow from with your home as collateral can foreclose if you fail to meet your loan obligations.

How to sell a home with a second mortgage

As long as we’re on the subject of second mortgages, what if you own a home with a second mortgage and want to sell it? Whether the second mortgage was originally silent or entirely legitimate, you’ll have to take it into account when you sell.

Selling your first home can be a Herculean undertaking if you’ve never done it before. And it can seem even more challenging if you’re worried that your second mortgage will complicate the process.

Don’t get yourself worked up, though. Having a second mortgage is not a barrier to selling your home. It makes little difference to the home-selling process since the second mortgage can be paid off during the sale. Paying off the second mortgage could significantly reduce the amount of profit you receive from the sale, though.

Sell a home with a second mortgage: key steps

  1. Examine the current appraised value of your home and the current amount owed on both mortgages combined. This will allow you to determine your potential profit. Will that profit be enough, for instance, to cover the down payment on another home?
  2. Make sure you verify early payment penalties that may be triggered by the sale of your home. Such penalties are likely if you’re selling a home shortly after taking out the second mortgage.
  3. Unless you prefer the for-sale-by-owner approach, contact a real estate agent and list your home. Before you list the home, though, get your mortgage paperwork in order for both mortgages. This will facilitate paying off the mortgages when the home sells.

Soft vs. silent second mortgage

To lie about where you get your down payment funds is mortgage fraud. Committing mortgage fraud via a silent second mortgage is not a good idea and could result in severe consequences. You could lose your home or spend time in jail.

If you are struggling to come up with a down payment, 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, you shouldn’t let a lack of a down payment keep you from becoming a homeowner. Options for getting a house with no money down now exist for qualified applicants, but you have to do your homework.

Are you a prospective homebuyer? Are you a first-time homebuyer? Why not look into down payment assistance loans and grants? A great place to start is our complete guide to down payment assistance programs.

Key takeaways

  • A silent second mortgage is a second mortgage placed on a piece of real estate that is not disclosed to the first mortgage lender. The funds borrowed are used to pay some or all of the down payment required by the first mortgage lender.
  • Lenders are at risk when a borrower fulfills the down payment using silent second mortgages because more debt is accumulated, and an additional lien is applied, against the collateral property.
  • Down payment assistance loans are a legal way to avoid taking out a silent second mortgage.
  • A second mortgage will normally be paid off during a home sale, so having one won’t stop you from selling your home. It may greatly reduce how much you profit from the sale, however.
  • Lenders offer lower rates on second mortgages than on credit cards because lenders are less likely to lose money on secured loans with valuable collateral.
  • A second loan payment can put a strain on your personal or household finances, especially if you’re already living paycheck to paycheck.
Sources and additional reading
  1. Mortgage Fraud — FBI
  2. General Information on Secondary Financing — HUD
  3. What Is a Junio-Lien? — CFPB
  4. A Complete Guide to Down Payment Assistance — SuperMoney
  5. Best Down Payment Strategies for First-Time Home Buyers — SuperMoney
  6. How to Prepare Financially before Buying a New Home — 10 Steps — SuperMoney
  7. How to Prepare Your Credit For Buying a New Home: 10 Tips — SuperMoney
  8. The Ultimate Guide To Buying A New Home — SuperMoney