With inflation at record highs, there’s no denying that money is tight these days. And when you’re spending more money on everything from food to cars, it can be extremely challenging to save up the money you need to buy a house.
If you’re sick of renting but aren’t quite ready to buy, you might be considering a silent second mortgage to help you out. Here’s what you need to know about a silent second mortgage and why you should be wary of it:
What Is a Silent Second Mortgage?
A silent second mortgage is a second loan that’s taken out in addition to a primary mortgage in order to cover the cost of the required down payment. It’s known as a “silent” second mortgage because the borrower does not inform the original mortgage lender about the existence of the second loan.
This is problematic because lenders require borrowers to disclose the source of their down payment funding. So, if the borrower lies about where it’s coming from or alters documents to hide it, they are misleading the lender.
How Does a Silent Second Mortgage Work?
When a borrower cannot afford to cover the cost of a down payment on their own, they may consider a silent second mortgage to cover this cost so that they can still purchase the home. They simply take out a second loan from an undisclosed source to cover the 20% down payment and don’t say anything about it to the lender.
If you’re still confused about how a silent second mortgage works, here’s a quick example to give you a better idea:
Say you found a perfect home that costs $300,000 and say that you qualified for a mortgage loan of $240,000. You would then be required to pay the remaining 20% or $60,000 with your down payment.
However, you don’t have the full $60,000 and decide to take out a loan of $50,000 and only use $10,000 of your own money. The second loan of $50,000 is a silent second loan since you’re using it to pay your down payment without the knowledge of your original lender.
Are Silent Second Mortgages Legal?
If you do not inform your lender that you’re taking out a second loan to afford your down payment, then it is considered an illegal practice since it’s against the law to lie or mislead lenders about your finances.
Doing so is considered mortgage fraud, and mortgage fraud is classified as a Class C felony under federal law.
What Are the Risks of a Silent Second Mortgage?
Using a second mortgage to buy a home without your lender knowing comes with a lot of risks. For starters, it’s illegal, so that’s a huge risk. If you use a silent second mortgage and get caught, you could be charged with mortgage fraud.
The Federal Bureau of Investigation (FBI) defines mortgage fraud as any “misstatement, misrepresentation, or omission in relation to a mortgage loan which is then relied upon by a lender.” Using a silent second mortgage is clearly mortgage fraud as it misrepresents your ability to cover the entire down payment on your own.
There are several types of mortgage fraud, but the FBI doesn’t discriminate against these different types and considers them all serious offenses that can lead to prosecution and potential jail time for those who are convicted of this crime.
If you are convicted of mortgage fraud, you may be sentenced to up to 30 years in federal prison and be required to pay a fine of up to $1 million.
Legal Alternatives to Silent Second Mortgages
When it comes to a silent second mortgage, the risks clearly outweigh the benefits. So what can you do if you’re having trouble affording a down payment on a home? The good news is that there are plenty of perfectly legal alternatives to a silent second mortgage.
These can help you afford your down payment:
1. Down Payment Assistance Programs
There are down payment assistance programs available to those who qualify. These programs are often offered by several different entities at federal, state, and local levels. To qualify for these programs, you’re required to take a homebuyer education course that teaches you about buying a home and being financially responsible.
You also must meet certain income limits since these programs are designed for low- and moderate-income borrowers. In some cases, these programs can only be used to purchase homes in certain areas.
There may also be a maximum purchase price based on the area’s median home purchase price. Finally, you must be able and willing to contribute a portion of your own money toward the purchase of the home in addition to the money coming from the program.
In addition to federal down payment assistance programs, there are also federally-backed loan programs that you can use to reduce the cost of your down payment. These loans are provided by private lenders but are guaranteed by the federal government in the case that the borrower cannot repay the loan.
For example, there are Federal Housing Authority (FHA) loans that are more accessible to low-income borrowers thanks to lower credit scores and down payment requirements. With an FHA loan, your credit score has to be above 580, and you can put as little as 3.5% down.
3.5% is a huge improvement over 20%, making this program a great option for those who can’t afford to put the entire 20% down.
If you’re a qualified veteran, there are also Veterans Affairs (VA) loans that help veterans, service members, and their spouses purchase homes with no down payment required. Finally, there are also US Department of Agriculture (USDA) loans for eligible rural homebuyers that also don’t require a down payment.
Just keep in mind that if you put less than 20% down on a federally-backed loan, you’re required to pay a mortgage insurance premium (MIP) both upfront and on a monthly basis to help mitigate the risk taken on by the lender.
3. Soft Second Loans
There are many different forms of down payment assistance programs and one of them comes in the form of a soft second loan. A soft second loan is a loan that comes with extremely favorable terms for the borrower. In some cases, they come with a 0% interest rate.
For example, some down payment assistance programs will provide you $20,000 in assistance if you stay in your house for five years. So what they will do is give you a soft second loan of $20,000 with a 0% interest rate. Every year, they will forgive 20% of the value of the loan, in this case, $4,000, until the entirety of the loan is forgiven within the five-year time frame.
Unlike silent second mortgages, soft second loans are totally legal since the lender is aware of the situation.
4. Piggyback Loans
If you don’t qualify for assistance programs due to your income level but still can’t qualify for a jumbo loan to purchase a more expensive home above the conventional conforming loan limit, you may want to consider a piggyback loan.
Piggyback loans usually follow the “80/10/10” rule wherein you use a conventional loan to cover 80% of the home price, a piggyback loan to cover an additional 10%, and you pay the remaining 10% yourself with your down payment.
Using this approach allows you to avoid paying private mortgage insurance or PMI, which is required with down payments below 20%. This is a good option for those who qualify for favorable loan rates that would cost less than PMI.
Again, lenders are aware of your second loan, so this approach to achieving a lower down payment is perfectly legal.
5. Gift Money
Finally, the last legal alternative to a silent second mortgage is to use gift money for your down payment. Of course, this isn’t an option for everyone, but it’s definitely worth a try. Ask family members like parents or grandparents if they’re willing to help you out with your down payment.
If you’re purchasing a primary residence, there’s no limit to the amount of gift money that makes up a down payment. The giver only has to provide documentation through a gift letter that indicates that the money is a gift and does not need to be repaid.
Wrap Up on Silent Second Mortgages
There are legal and creative solutions to housing affordability issues that don’t involve taking out a silent second mortgage. So instead of taking this risky route, work with a flexible lender that will help you qualify for a loan that works for your financial situation. Vaster is a private lender with flexible qualification requirements that can help you finance the home of your dreams.