A seasoned appraiser told me that he is seeing a lot more listings lately that offer to carry 2nd mortgages for buyers, apparently as added enticements to move the listings.

In light of that, I thought I would touch on a few “do’s and don’ts.”

  1. Down Payment Still Required. If buyers want to obtain a first mortgage in front of the seller’s second mortgage, buyers still need to come in with a down payment equal to at least 5% of the purchase price in most cases. In other words, sellers cannot carry a second mortgage that is large enough to eliminate the need for a down payment, e.g. the first and second mortgages cannot equal the purchase price.
  2. Still Counted In Debt Ratios. First mortgage lenders will consider private 2nd mortgage payments when underwriting the first mortgage just like they do with institutional 2nd mortgages.
  3. Reasonable Interest Rate Required. Sometimes sellers will offer very low interest rates with their seconds as an added enticement. But, if the rate is too low, lenders will impute a reasonable or market rate for the second mortgage when underwriting the first mortgage. Fannie Mae, for example, requires seller mortgage interest rates to be no more than 2% below the standard market rate for 2nd mortgages. Otherwise, the subordinate financing (2nd mortgage) must be considered a “sales concession,” which would require that the financed amount be deducted from the sales price.
  4. Reasonable Term. First mortgage lenders also want to see a reasonable term for the 2nd mortgage, meaning that it will not come due in full for at least 3 years.
  5. Interest-Only Payments Are Kosher. Many sellers offer interest-only payments to make their seconds more enticing, and many first mortgage lenders have no qualms about that. Interest-only payments also make servicing easier, as nobody has to worry about monitoring amortization schedules. Note – Fannie Mae is OK with interest-only loans, but some mortgage lenders have “overlays” that require 2nd mortgages to be fully amortized, no matter what the promissory note says, for debt ratio purposes.
  6. Interest Rates Based on Combined Loan-To-Value (Not On First Mortgage Loan-To-Value). If the combined loan-to-value is over 80%, buyers will still be hit with the interest rate adjustment that comes with higher combined loan-to-value financing with 2nd mortgages – unless the buyers are first-time homebuyers (for whom those adjustments are waived). This impact can be mitigated in some cases, if the 2nd mortgage is large enough to reduce the first mortgage below 75% or 65%.

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