What Is a Silent Second Mortgage?

A silent second mortgage is a second mortgage placed on an asset (such as a home) for down payment funds that are not disclosed to the original lender on the first mortgage. The second mortgage is called "silent" because the borrower does not disclose its existence to the original mortgage lender. While lenders require borrowers to disclose the source of all down payment funding, in some instances lenders fail to catch the existence of a silent second mortgage. Silent second mortgages that are not disclosed to the original lender are illegal and borrowers who use them could be prosecuted for mortgage fraud.

Key Takeaways

  • A silent second mortgage refers to a second mortgage on an asset (such as a home) that the borrower uses to pay for the down payment and does not disclose its existence to the lender of the first mortgage.
  • Borrowers who do not disclose the existence of a silent second mortgage to the first mortgage lender could be fined and convicted of mortgage fraud.
  • Silent second mortgages pose a risk for lenders because they add an additional form of debt that is secured against the collateral.
  • Government-funded down payment assistance programs can be a good alternative for prospective homebuyers who have difficulty coming up with the money needed for a down payment.

How a Silent Second Mortgage Works

Silent second mortgages are used when a buyer can't afford the down payment required by the first mortgage. They allow a borrower to purchase a home that they otherwise would not have been able to afford. Silent second mortgages from undisclosable sources are illegal. However, a number of legal down payment assistance programs sponsored by government agencies do exist to provide down payment funds from acceptable sources.

When a buyer purchases a home, the arrangement requires the borrower to provide a down payment. A lender will typically request that the borrower completely disclose the sources of down payment funds when completing a mortgage deal. Fraud or illegal actions can occur when a second mortgage is used to fulfill the obligation of the down payment without being reported to the lender. In this situation, silence refers to a lack of transparency and disclosure.

For example, let's say you wish to purchase a house for $250,000. You have secured a mortgage for $200,000, which requires a down payment of $50,000. You don’t have the full $50,000 in cash or liquid assets for the down payment; you only have $10,000. So you decide to take a silent second mortgage of $40,000. The original lender believes your down payment to be $50,000 when it is actually only $10,000 ($50,000 - $40,000).

Silent Second Mortgage Risks

A borrower is required to report a down payment second mortgage to a lender since the second mortgage is also secured against the specific collateral, which in the case of a home mortgage would be the home itself. Lenders generally require cash for the down payment which is factored into the overall terms of the first mortgage loan.

If a borrower were to obtain a second mortgage against the collateral, it would affect the risks and loan term for the first mortgage lender. The second mortgage would increase the risk since it adds an additional form of debt, including new interest payments. Additionally, the first mortgage lender seeks full collateral rights to a specified piece of collateral and a second mortgage would conflict with the first order secured collateral rights given to the initial mortgage lender.

Down Payment Assistance Programs

Borrowers do have the option to identify a down payment assistance program for help with paying their down payments. A down payment assistance program can provide funds to the borrower and are allowed for legal disclosure to the lender of a first mortgage. Down payment assistance programs are not as easy to identify as a loan; however, there are over 2,000 programs across the United States.

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

Requirements for down payment assistance programs are slightly lower than for standard loans. Borrowers follow similar lending procedures in that an application is required with personal information, including income, occupation, and credit history.

Down payment assistance programs can offer from $1,000 to approximately 20% of a property’s appraised value. Down payment assistance funds do require repayment with interest. However, interest generally does not compound and is usually lower than a standard loan.