How Do Silent Second Mortgages Work? - SmartAsset

When it comes to buying a home, a down payment is a major obstacle for most buyers. A silent second mortgage provides an opportunity to obtain the funds you need for a down payment but there’s a right way and an illegal way to handle this option. In general, you must notify the original lender about the second mortgage or you may be violating both your original loan documents and the law. As you navigate the home buying process, consider working with a financial advisor to help create the right homeownership plan for you.

What Is a Silent Second Mortgage?

Most of us know what a mortgage is. It’s a loan that buyers can use to purchase a property. The loan involves using the home as collateral. With that, the lender has the right to take the property if the borrower defaults on the loan. A second mortgage is another mortgage that’s tied to the same property. But it becomes “silent” if the borrower doesn’t disclose the source of these funds to their mortgage lender.

If you don’t disclose the source of your down payment funds to the original mortgage lender, that’s an illegal move that is also a likely violation of your loan documentation with the original lender. If the original mortgage lender finds out about an undisclosed silent mortgage, the borrower could face mortgage fraud charges and you may lose the property.

How Does a Silent Second Mortgage Work?

Borrowers that can’t afford the down payment required for a home loan may turn to a second mortgage. Essentially, the second mortgage allows them to borrow the funds they need to cover a down payment. Many lenders will frown on this behavior and want the funds to actually come from either you or from someone who gifts the funds to you. Borrowing additional funds could negatively impact your debt-to-income ratio enough to prevent you from getting the original loan.

In general, mortgage lenders are very diligent about finding out where borrower down payments come from. The borrower is required to disclose where the funds came from. But if a silent second mortgage slips through the cracks, that’s actually not good news for the buyer. Although that misstep might allow the borrower to close on the home, it could lead to mortgage fraud charges down the line. The lack of disclosure is what makes silent second mortgages illegal.

Why Get a Silent Second Mortgage?

If you don’t have the funds to cover a down payment, a silent second mortgage can be a tempting option because the vast majority of mortgages require a down payment to qualify for the loan. Although conventional wisdom suggests saving 20% for a down payment, you may only need to put down 3% for many mortgages, especially if it’s your first home. However, with the average home sale price sitting at $453,700 for the U.S., that’s still a considerable amount of money for many.

Risks of a Second Mortgage

Since a second mortgage uses the house as collateral, that adds more risk for the borrower and the lender. The original lender, who is putting up more of a risk by giving you more money, will want to make sure that they lock in a “first position” lien on the property meaning they get all of their money back before the second mortgage lender gets anything.

Borrowers that take out a second mortgage of any kind will also have additional payments putting a crunch on their budget. If the borrower defaults, then two lenders will each have conflicting claims to the same collateral asset. Issues that could arise from conflicting claims are one reason why many mortgage lenders don’t allow silent second mortgages.

Alternatives to a Silent Second Mortgage

Although undisclosed silent second mortgages are illegal, that’s not the only way to obtain funds for a down payment. If you can’t afford a down payment, here are some options for you to get the funds you need so that you can buy your home.

Low down payment mortgage loans. If you think you need a 20% down payment on a home, think again. There are actually many low-down-payment mortgage options. You may only need to put down 3%. Explore your mortgage options to see how much you actually need for a down payment before you start considering a silent second mortgage.
No down payment mortgage loan. As a qualifying military service member or veteran, you could tap into the VA home loan backed by the Department of Veterans Affairs. Although there is a funding fee, you won’t have to make a down payment in some cases.
Down payment assistance programs. Down payment assistance programs are offered through housing authorities and nonprofits. Some lenders even administer down payment assistance programs directly. These programs are very different from silent second mortgages because you’ll disclose the details to the lender. But the result is the same, you’ll have the funds you need for a down payment.
Money that was gifted to you. If you have someone that is willing to offer down payment funds as a gift, that’s exciting. Although you can use gift money as a down payment, there are some rules to abide by. Specifically, you’ll need to have specific documentation. Here’s where you can find out information about gift money rules.

Bottom Line

You cannot lie about the source of your down payment funds to your lender. Although a silent second mortgage might not be a great option, there are other choices for home buyers. Whether you go with a down payment assistance program, a low down payment mortgage, or both, there’s no need to sneak around the rules of your mortgage lender. If you do you could just end up losing your home and breaking the law.

Tips for Home Buyers

Buying a home is a major financial goal that can be difficult to tackle. As you gear up to make this purchase, it’s a smart move to work with a financial advisor who can help you make a plan for homeownership. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
You don’t want to buy a more expensive house than you can afford. Use our free house affordability calculator to explore your options.
You might not need to put down as much as you think. Use our down payment calculator to find out how much you’ll actually need to have on hand.