What is a silent second mortgage?

It’s possible to get a loan to overcome the homeownership obstacle posed by a down payment for a mortgage, but you need to disclose it to the lender. Hiding a second mortgage is referred to as a silent second mortgage. We’ll go over alternatives, because the penalty for being less than truthful about funding sources isn’t worth it.

How silent second mortgages work

A silent second mortgage involves taking an additional loan against collateral without disclosing it to the initial lender. This is a form of mortgage fraud, punishable by up to 30 years in prison and/or a fine of up to $1 million as a federal crime. States also have their own statutes.

Let’s say Ricky wants to buy a $350,000 house. They make an agreement with their lender to fund the mortgage based on a 20% down payment, meaning the mortgage is $280,000. But Ricky only has $35,000 available for the down payment. They borrow $35,000 from a friend with a promise to pay at a later date. Since they do not tell the lender about this $35K, this is called a silent second mortgage.

If the lender finds out about that money, not only will Ricky’s application likely be denied, but there’s the potential for mortgage fraud charges. If the lender doesn’t catch it up front, you can also be charged later on after the mortgage closes. So it’s always best to just tell where the money is coming from.

Of course, if you disclose to the lender the source of the funds, that’s perfectly legal. Lenders originate second mortgages all the time. Solutions like home equity loans allow homeowners to access the existing equity in their homes without touching their primary mortgage rate. They can also be used by purchasers to cover down payments.

Why silent second mortgages are risky

Silent second mortgages are problematic because an undisclosed loan from another person or entity means that an individual or other lender could have a right to the property. Because your home serves as collateral for a mortgage, the lender is basing their loan on being able to take the home back if you can’t make the payments.

If there are liens on the property that go undisclosed, the original lender faces potential problems getting paid in the event of foreclosure. If they know about it, the second loan is usually a subordinate mortgage, meaning the primary lender gets paid first in a sale. If they don’t, that’s not necessarily the case and the risk goes up.

Even beyond the legal risks, there are two big issues with silent second mortgages for borrowers:

• Sources who would be willing to take the risk of giving you a loan without telling the primary lender are also taking a huge risk and may expect an interest rate to match. You’re also paying more interest based on having two loans.
• Because a silent second is undisclosed, you don’t have the option to refinance it into the primary mortgage down the line even if doing so would yield more favorable terms.
• Your home equity builds slower, which can limit your options to do things like consolidate debt or make home improvements.

Use down payment assistance programs instead of silent second mortgages

Down payment assistance is intended to aid those who can afford a monthly payment in covering the down payment gap. It can also be used to cover closing costs. It can come in the form of grants or loans. Typically offered to first-time home buyers, assistance may also be available to low- to moderate-income households.

It’s a better option than a typical second mortgage because the assistance sometimes comes in the form of grants. If you do have to pay it back, the loans are often made on more favorable terms.

How down payment assistance works

Down payment assistance is often available through local and state governments as well as housing-focused nonprofits. The amount you can get is going to vary widely. It might be in the range of $5,000 or more than $200,000. However, there are usually certain restrictions. Let’s run through some of the qualification questions:

• Are you a first-time home buyer? The definition often used by mortgage lenders is that you haven’t owned residential property in the last 3 years. There are typically exceptions for displaced homemakers and single parents who have only owned jointly with their spouse in the past. But the providing organization may have its own standards.
• Do you meet income thresholds? Alone or in combination with a first-time home buyer requirement, programs may be set up to serve people who make below a certain income amount. It’s often not a dollar figure, but instead a percentage of income relative to the area you’re looking to purchase.
• What’s your credit score? The organizations who administer these programs often want to see that the people who get the assistance have a good chance of being able to afford and maintain the home. As part of this, they may run a credit check.
• Do you have some down payment savings? It varies, but lenders and sometimes the assistance providers themselves will require a minimum down payment contribution at closing from a home buyer.

What is a ‘soft’ second mortgage?

Down payment assistance that comes in the form of a loan is sometimes referred to as a “soft” second mortgage because of terms that are considered more favorable for borrowers. Some of the common advantages of DPA loans as compared to others include:

• May be forgivable: Forgivable loans only have to be paid back if you violate the conditions of the forgiveness. It’s going to vary by program, but a typical requirement might be staying with an employer you got the assistance from for a certain period or occupying the home for a minimum number of years.
• May be deferred: Payments on your DPA loan may be delayed a number of years. If not tied to a time frame, the loan may not be due until you refinance or sell the home.
• May have below-market interest rates: In some cases, DPA loans are available at rates you won’t find on the market.
• The Department of Housing and Urban Development (HUD) maintains a list of state resources including available sources of DPA.

Rocket Mortgage^® and down payment assistance

Check with your lender because they each may have their own requirements regarding the types of assistance they accept. Down payment assistance requirements at Rocket Mortgage include:

• Grants have to be generally available for other recipients and cannot be created just to help one person.
• We accept funding from 501(c)(3) nonprofits, federally registered Native American tribes, local municipalities and government entities, as well as employer assistance. For FHA loans, nonprofits must be approved by HUD.
• We don’t accept assistance provided by housing finance agencies, state housing authorities, or regional Federal Home Loan Banks.

Besides DPA, another avenue to consider is gift funds that you get from friends or family. The funds for the transaction have to be sourced. You also need a letter from the donor stating that the funds don’t have to be paid back. These can be used toward your down payment and closing costs.

The bottom line: Avoid the risks of silent second mortgages

Silent second mortgages are those that aren’t disclosed to the lender of the primary mortgage. While some might see this as an avenue to pay for the down payment and closing costs associated with home buying, these are illegal. It’s better to look at down payment assistance options like grants and loans than to risk fines and prison time.

DPA comes in the form of forgivable, deferred, or low-interest loans, or grants you don’t have to repay. Gift funds are also a solid option. A good place to start is searching the Internet for the available programs in your area. If you feel more confident and you’re ready to look into your mortgage options, you can apply online.