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 counted on. When equity is depleted, some borrowers stop paying on their mortgages.
This silent second is also risky to the seller because it can’t be recorded at the time of the sale — that would give the game away. This means that the seller has an unsecured loan until the transaction is completed and the lien can be recorded. How long the seller must wait before recording the lien is negotiated between the parties. The longer the seller waits, the greater the risk that other liens will be placed on the property, which will endanger the silent second.
An even more serious deception of the first mortgage lender arises when the silent second is used to inflate the sale price beyond the true value of the house in order to increase the size of the first mortgage. Assume the same house as before with buyer and seller agreeing on a true price of $200,000, but in this case the buyer has no down payment. They collude to set a fictitious price of $222,200, on the basis of which the first mortgage lender agrees to lend $200,000. This is 90 percent of $222,200 but 100 percent of the true value of $200,000. The seller agrees to a second mortgage for $22,200.
In this case, the first mortgage lender knows about the second mortgage. What the lender doesn’t know — where the silence comes in — is that after the transaction is completed the seller will forgive the second mortgage. In this way, the lender is deceived into making a 100 percent loan, believing that it is a 90 percent loan.
Borrowing Someone Else’s Bank Account to Buy a House
“I am in the market for a home. I have good credit but not the substantial assets needed to get a good rate. I know a real estate attorney who will temporarily move me on to one of his bank accounts so I will be able to show stronger reserves. He charges a small fee for this, and once the deal is funded I will be removed from his account. I really need to know if this transaction is 100 percent legit?”
How can showing someone else’s money as your own be legit? When you sign the mortgage application, attesting to the truthfulness of the information shown there, you will be perjuring yourself.
And to no purpose. Showing higher cash reserves will not get you a better price unless you use the reserves to increase your down payment. This you can’t do because the money is not yours to be used.
Lenders do want borrowers to have a cash reserve on top of the cash required for down payment and settlement costs. Flashing someone else’s bank account as your own could meet that requirement, but this required reserve is extremely modest, typically amounting to no more than two or three monthly payments.
When you buy a house, you can be 100 percent certain that unanticipated expenses will arise. That is what the reserve requirement imposed by lenders is about. If you can’t meet their modest requirements with your own funds, you should seriously reconsider whether you are ready to purchase a house.
And that lawyer ought to be disbarred.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.