Why ‘silent’ second mortgages are so risky

Lenders most likely to be holding the bag
Published on May 14, 2007

The term "silent second" is used to describe self-serving or perhaps fraudulent schemes where house sellers accept second mortgages as part of a sale transaction, without the full knowledge of the first mortgage lender. The "silence" refers to the absence of full disclosure to the first mortgage lender. The smaller of the frauds arises when the second mortgage replaces part or all of a down payment. For example, the buyer and seller agree on a price of $200,000; the buyer has a commitment for a first mortgage loan of $180,000, but doesn't have the $20,000 required for the down payment. To make the deal work, the seller agrees to accept a silent second mortgage for $15,000. As far as the first mortgage lender knows, the down payment is $20,000, but in fact, it is only $5,000. The silent second increases risk to the first mortgage lender because it takes only a 2.5 percent decline in home value to eliminate the borrower's equity -- rather than the 10 percent decline that the lender coun...