Purchase Money Second Mortgage

Purchase Money Second Mortgage

Renting vs buying, this is a much debated for thought for most families, however, more times than not the hard part of buying a home can be coming up with the down payment for the mortgage, this is where a Purchase Money Second Mortgage comes into consideration and may be the answer for you1. Purchase money second mortgages are similar to standard purchase money mortgages. One major difference is one is a second mortgage lien position, and the other is in first lien position.

A purchase money mortgage occurs when the buyer obtains a mortgage from the seller of the subject property. The seller may use this strategy as a way to help sell the property, or perhaps the buyer lacks credit or cash down payment. These types of loans may also be referred to as private mortgages. New Century Financial Mortgage works with clients in these situations, see if you qualify for the first mortgage by applying for a free rate quote.

The Purchase Money Second Mortgage is a loan that simultaneous closes with a first mortgage along with your down payment. For instance, if you want to purchase a home, put 10% down, the lender approves you for 80% Loan To Value, or the house’s appraised value. This means you will need 10% more to complete the transaction and make up the difference. This is also called a seller held second mortgage, or a Piggyback Mortgage. This may be a unique strategy to help avoid paying Private Mortgage Insurance. Private mortgage insurance is generally paid by the buyer on any mortgages that lends out greater than 80% LTV. Other strategies include obtaining seller concessions for use of closing costs, and some loan programs even allow gift funds from family and others.

What is a Purchase Money Second Mortgage?

When buying a $300,000 home, the first lien position mortgage generally has the larger loan amount. As an example, the first lien would be $240,000 or 80% LTV. The second mortgage is in a less superior position on title, you may put down $30,000 or 10% LTV. The first and second-lien positions now add up to 90% LTV, which means you need to make up the difference and put down the remaining $30,000 or 10% LTV. Meaning by not borrowing over 80% LTV for your first mortgage, you avoid PMI.

The Rule of Thumb

If you were to ever default on the property, the first lien position holds the superior position on title. This means if the bank were to sell your property, the first lien position would have the ability to recoup their losses. The second-lien position would have to wait to see if the sale of the property will have enough excess funds to satisfy the first lien position in order for it to be paid. This second position inherits risk, they may not recoup any money if the property went into default. There are certain items that could leapfrog the all lien positions, including the first, such as past due taxes.

How Does it Work?

There are several options, but two of the most common are purchase money second mortgages, and standard second mortgages. What is the difference? The purchase money second mortgage comes from the seller. However, the lending institution finances the standard second mortgage.

For a standard second mortgage, if you secure funding from the same lender as your first mortgage, there’s very little you must do. After you apply for the loan, the lender has most of everything else they need. They’ll process your application using the same income, asset, and credit information you provided for the first mortgage.

At the closing, you’ll close on two loans rather than one. This just means signing two sets of closing documents and agreeing to take two liens on your home rather than one.  If you sell the home, you must pay off both loans in order to release the liens on your property and transfer homeownership. 

What are the Terms?

Like your first mortgage, the purchase money second mortgage has varying terms depending on the lender. Lenders may offer various terms, but usually they are shorter than the first mortgage. Second mortgages often offer a secure fixed interest rate and most don’t have a prepayment penalty so you’re free to pay off the loan whenever you want.

Utilizing a second mortgage initially might free up your cash initially, but keep in mind that second mortgages generally hold a higher note rate. Make sure to set a plan to either consolidate the loan or pay it off by making extra payments throughout its term. Penalties or fees associated with your loan may occur, make sure to be prudent and do your due diligence.

What are the Benefits of a Purchase Money Second Mortgage?

Avoiding PMI, as the PMI charge may be greater than the cost of a second mortgage. Therefore, a first mortgage that allows you to borrow 90% may be more expensive than an 80% first mortgage and a 10% second mortgage at a higher note rate.

In Addition, if a seller is motivated, but perhaps the lender is capping the loan to 80%, along with your 10% down, or a total of 90% CLTV (80%+10%) or complete loan to value, the seller may be motivated to use a purchase money second mortgage (PMSM) to help seal the deal. The interest on the PMSM may be tax deductible, you should consult your CPA to confirm.

Are there Downsides?

When reviewing the benefits and features of a product, one must always recognize there is almost a downside. One of the downsides might be you may pay a higher rate of interest due to the risk factors involved. Equity in the subject property is used as collateral in a cash refinance. In Addition, Purchase Money Second Mortgages generally inherit all the risks as any other standard mortgage as well.

Purchase Money Second Mortgage is a private and may not report to the credit bureaus. This could mean that any payments you make, you will not receive credit for paying them on your credit profile. Due to this, obtaining a mortgage history may prove to be more difficult to obtain. Second mortgages call for a higher note rate than first mortgage lien positions. Therefore, the interest you pay can be significant over the life of the loan. A private mortgage may not be as regulated, therefore the terms may be less favorable. This means the terms of the loan may not be as favorable as you would like. Prior to obtaining the mortgage, seek the advice of an attorney, CPA and other real estate professionals. These are just a few of the many downside risks, make sure to do due diligence up front.

Alternative Types of Purchase Money Second Mortgage

Besides the Purchase Money Second Mortgage, there are other options. Assistance may help for your down payment. The state of Florida has options that may fit your need.

The various programs from State Housing Initiatives Partnership (SHIP) may be of interest to you2.

Non-repayable grants

Zero-interest loans

Deferred second mortgages

These programs are a part of a few ways that can help you get into a home.

Home equity line of credit: This is another second mortgage that pulls on your home equity, only this time it’s a line of credit, like a credit card. You don’t have to draw funds out initially. You can leave the funds untouched in the credit line. When you need the funds, you may use them, paying interest only on the money you withdrew, not on the entire line.

PMI and a Second Mortgage

Each borrower has different circumstances. In some cases, it may be better to pay PMI rather than obtaining a Purchase Money Second Mortgage. Mortgage insurance may go away once, however, a second mortgage will not. How quickly will you owe less than 80 percent of the home’s value? If you have enough to put down that you get close to the 80 percent threshold, you may want to stick with the first mortgage and PMI. You may request that the lender drops PMI, this is up to the lender.

How long will you live in the home? If you aren’t making a large down payment, think about how long you’ll be in the home. Is it worth avoiding PMI by taking out a second mortgage? Remember, you will pay closing costs and interest. If this is your ‘forever home’? Consider this because you may benefit during tax season rather than paying money toward PMI, of course consult your CPA. Will you pay the mortgage down faster or make the minimum payments? If you are make minimum payments, you may not eliminate PMI any faster and may benefit more from the second mortgage. If you make larger payments, though, you may request to drop PMI faster.

In Conclusion

The purchase money second mortgage is one of the ways to help avoid paying PMI. Many borrowers don’t want to pay more and that’s okay. Using a second mortgage is an acceptable way to get around it. 

If you put down 20% on the home to avoiding PMI, then this may cost you less in the long run.

Look at the big picture to see what suits your situation. No two situations are alike and there isn’t one solution that’s a one-size-fits-all. We can connect and discuss with you to go over your options. But you ultimately you will need to figure out your bottom line, your financial goals, and what will leave you with the best outcome not only on your monthly payment but for the overall cost of the loan. 

Sources

  1. Second Money Purchase Mortgage https://www.law.cornell.edu/wex/purchase_money_mortgage

2. Florida Down Payment Assistance (Ship) http://lendercalculator.com/florida-down-payment-assistance/