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.”
- 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.
- 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.
- 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.
- 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.
- 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.
- 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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