A first mortgage is what we think of when we purchase a home for sale. To obtain it, you speak with a lender, they pull your credit history, ask about your income and debts, request the amount of your down payment, and determine the amount of home you can afford. If your debt-to-income ratio changes at all during the home-buying process, it can lower the amount of home you can afford. That’s why we always recommend buyers don’t take out any additional loans or open any new lines of credit until after closing. That includes store credit cards and auto loans.
Sometimes, buyers don’t have enough money to cover a down payment or closing costs. To try and amend this, they look for additional funding. When they realize a second loan will show up on their credit history and ruin their debt-to-income ratio, they consider loan sources that won’t report to the credit bureau, like a personal friend, private lender, or hard money lender.
When the buyer purchases the home, it will look like they are using their personal money when, in fact, it is lent money. This is a silent second mortgage and is fraudulent and illegal.
Understanding Silent Second Mortgages
A silent second mortgage is a type of second mortgage placed on a home, bearing the name “silent” because it is hidden from the first lender. This secondary loan is not disclosed to the first mortgage lender, which can cause serious issues if the property goes into foreclosure. The danger here is that the first mortgage lender believes they have the first claim to the collateral in the event of default, but the presence of a silent second mortgage changes that.
The Risks of a Silent Second Mortgage
Silent second mortgages can significantly increase the risk of default. The home buyer is taking on more debt than the primary lender is aware of, which can violate the terms of the first mortgage. The primary lender determines the amount of money to lend in accordance with the risk of default based on the information the borrower and credit bureau provide. If this information is misrepresented, the lender is at a higher risk of losing the money they lent.
Buyers also need to realize that taking out an extra loan, even a private one with special terms, puts their financial health at risk. Lenders have detailed formulas to follow when determining how much mortgage payment a borrower can afford. This includes leeway for when unexpected expenses arise. Everyone who loans money, even family, expects it to be repaid. If you face financial hardship, there are fewer options with private loans to prevent a foreclosure.
The housing market is also affected by silent second mortgages, which can distort the true value of properties and the level of risk in the current market. This was seen in the run-up to the 2008 financial crisis, where silent second mortgages and other risky lending practices contributed to a housing bubble.
Don’t Confuse Them with Second Mortgages
Silent second mortgages should not be confused with traditional second mortgages. A second mortgage is a type of subordinate mortgage made while the original mortgage is still in effect. A second mortgage is essentially a loan that is secured by your home, similar to the original mortgage, but it ranks behind the first mortgage in terms of repayment priority. In these instances, the original mortgage takes precedence, and the second mortgage is subordinate to the first. Unlike silent second mortgages, traditional second mortgages are disclosed to lenders allowing them to accurately determine the level of risk for lending money.
The amount you can borrow through a second mortgage is typically based on the equity you have built up in your home. The equity is the market value of the home minus any amounts owed on any mortgages or other liens. Second mortgages often have higher interest rates than first mortgages as they carry more risk for the lender; if the borrower defaults, the first mortgage gets paid off before the second. The term of a second mortgage can vary widely, from a few years to 30 years or more. The terms will be specified in the loan agreement.
There are two types of second mortgages:
- Home Equity Loans: These are standard loans that provide a lump sum amount which is repaid over time. The interest rates are usually fixed.
- Home Equity Lines of Credit (HELOCs): These function more like credit cards, where you have a credit limit and can borrow up to that limit. The interest rates are usually variable.
These types of loans can help you consolidate debt, complete home improvement projects, pay off education or medical expenses, and provides funds for real estate investments.
They’re Also Not Down Payment Assistance Programs
Down Payment Assistance (DPA) programs are designed to help potential home buyers overcome one of the most significant barriers to homeownership: the down payment. These programs are usually government sponsored and provide financial assistance, making homeownership more accessible, particularly to first-time buyers or low- to moderate-income families.
DPA programs aim to assist individuals and families who may struggle to save enough money for a down payment on a home. By reducing the upfront financial burden, these programs help make homeownership a feasible goal. They come in a few different forms:
- Grants: Some DPA programs offer grants that do not need to be repaid.
- Zero-interest Loans: Others provide zero-interest loans that are repayable upon the sale of the home or once the primary mortgage is paid off.
- Low-interest Loans: There are also low-interest loans that require repayment on favorable terms.
Eligibility for DPA programs often hinges on income level, credit score, and sometimes the location of the home being purchased. First-time home buyers are a common target group for these programs, though the definition of “first-time home buyer” can vary. DPA programs may be funded by federal, state, or local government agencies, non-profit organizations, or even private sector entities. Some programs require participants to complete homebuyer education courses to ensure they fully understand the responsibilities of homeownership. Whichever DPA a buyer chooses, it should not negatively affect their ability to secure a primary mortgage.
Loans with Low Down Payments
If you’re struggling to save a down payment, you may be interested in loans that offer a small percentage down, including 0% in some cases. Below is a list of loans that you could benefit from considering.
1. Federal Housing Administration (FHA) Loans
FHA loans are a popular choice for first-time home buyers, offering down payments as low as 3.5% for those with credit scores of 580 or higher.
2. Veterans Administration (VA) Loans
VA loans are available to eligible veterans, active-duty service members, and some members of the National Guard and Reserves. They offer a zero down payment option and have competitive interest rates.
3. United States Department of Agriculture (USDA) Loans
Designed for rural and suburban home buyers who meet certain income requirements, USDA loans also offer a zero-down payment option.
4. Conventional Loans with Private Mortgage Insurance (PMI)
Some conventional loans allow for down payments as low as 3% but require private mortgage insurance (PMI) if the down payment is less than 20%. PMI can be removed once you build enough equity in your home.
5. HomeReady and Home Possible Loans
6. Employer Down Payment Assistance Programs
Some employers offer down payment assistance as part of their benefits package, particularly in high-cost areas or industries that need to attract a specific talent.
7. 80-10-10 Piggyback Loans
An 80-10-10 loan involves taking out two mortgages simultaneously. The first mortgage covers 80% of the home’s price, the second mortgage covers 10%, and the borrower puts down 10%.
8. Credit Union Loans
Some credit unions offer special mortgage programs with lower down payment requirements.
If you would like the name of a reputable local lender that we’ve had good experiences with, please reach out. We are happy to send along contact info for multiple people – no pressure to use any specific lender. We want you to choose someone you feel comfortable with.