Sara Routhier, Managing Editor and Outreach Director, has professional experience as an educator, SEO specialist, and content marketer. She has over five years of experience in the insurance industry. As a researcher, data nerd, writer, and editor she strives to curate educational, enlightening articles that provide you with the must-know facts and best-kept secrets within the overwhelming world o...

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Joel Ohman is the CEO of a private equity-backed digital media company. He is a CERTIFIED FINANCIAL PLANNER™, author, angel investor, and serial entrepreneur who loves creating new things, whether books or businesses. He has also previously served as the founder and resident CFP® of a national insurance agency, Real Time Health Quotes. He also has an MBA from the University of South Florida. ...

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Reviewed by Joel Ohman
Founder, CFP®

UPDATED: Sep 14, 2012

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Fraud is an unfortunate threat in many situations where money changes hands. Even in home purchases fraud can rear its ugly head. One way some home sellers and buyers commit fraud is through silent second mortgage loans.

A silent second is a type of second mortgage loan that is part of a home sale transaction without the knowledge of the first lender. The “silent” part refers to the seller and buyer not “speaking” to the first financer about a second mortgage loan. In most instances, silent second home financing is a form of fraud and thus highly illegal.

A Fraud Tutorial

To summarize what a silent second is, let’s first review how the mortgage financing process works. Whenever financers lend money to borrowers, they do so at a risk. If the borrower defaults, the lender can potentially lose a lot of money. In order to mitigate this risk, financers ask borrowers to put up a down payment. That way, borrowers have “skin in the game,” so to speak, and it then is in a borrower’s best interest to fulfill his or her monthly payment obligations.

But a silent second circumvents that down payment form of security by allowing the borrower to lie to a lender regarding his or her down payment.

That sidestepping occurs when a financer agrees to lend money contingent on receiving a certain amount down from a borrower, but then the borrower takes out a second mortgage loan (worth only the amount of the agreed down payment) and pays the first financer’s down payment requirement with funds from that second mortgage.

An example can help illustrate this process:

A home seller and a home buyer agree on a price of $200,000 for a home. The buyer has been approved for financing worth $180,000 from a lender, but doesn’t have the remaining $20,000 for a down payment. Instead, the buyer can only afford a $5,000 down payment.

In order to finish the deal, the seller offers to accept a silent second mortgage for $15,000.

So the borrower approaches a new financer, qualifies for a $15,000 loan, and purchases the home by giving his first lender $5,000 plus $15,000 from the silent second.

However, his original financer is completely unaware that the majority of the borrower’s down payment is from a second mortgage loan.

Since the bulk of the down payment is in the form of financing, the home buyer has only a few thousand dollars invested in the home. If the home decreases in value by a few thousand dollars then all of the buyer’s equity would be wiped out, and the borrower would have less incentive to keep up with his payments

A borrower is “silent” when he or she refuses to reveal to the first lender that there is a second mortgage loan.

The Fraud of Collusion

There is another form of silent second mortgage loans that is arguably even more malicious:

A buyer and a seller are in negotiations for a $200,000 house. If a buyer is unable to obtain money for a down payment, the buyer and seller may collude together in order to raise the price of the home to $222,000.

A financer agrees to lend $200,000 expecting the buyer to make a down payment for the remaining $22,000. Unbeknownst to the financer, the $200,000 that was borrowed is actually the complete value of the home. The borrower obtains a second loan for $22,000 knowing that the seller is already satisfied by having the full value of the home.

Unlike the previous example, in which the lender is unaware of the second home financing, the original financer in this situation does know about the second mortgage. However, he or she does not know about the collusion between the buyer and seller.

Once the transaction is complete the seller simply forgives the second mortgage.

As a result, the first lender was deceived into offering money for the complete value of the home. The financer assumed the mortgage was for only the majority of a home’s value and that the borrower would make a larger down payment in order to create equity in the home.

This form of fraud using silent second mortgage loans is a little harder to undertake because a higher price must be ratified by an appraiser.

Piggybacks and Caution

Prospective borrowers should keep in mind that a silent second mortgage is different than a “piggyback” loan. A “piggyback” loan is a second mortgage loan that is legally used as a down payment. Since the lenders of first mortgages offer “piggyback” financing there is no possibility that any party can be “silent” in the financing process.

Borrowers should never try to undertake a silent second mortgage loan despite the allure of profit and savings. Fraud is a serious crime that can result in civil and criminal charges.

Likewise, borrowers must be cautious that a seller does not plan to conduct a silent second mortgage scheme. To avoid this temptation, borrowers should altogether avoid home sellers that have past experiences with or hint at performing fraud schemes.