Purchase Money Second Mortgages
Renting vs buying, this is a much debated 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 you. Purchase money second loans 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 loans. MortgageQuote.com 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 simultaneously closes with a first mortgage along with your down payment. For instance, if you want to purchase a home borrowing 90% and 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 holding a second mortgage, or a Piggyback. This may be a unique strategy to help avoid paying PMI. PMI is generally paid by the buyer on any loans 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 Second?
When buying a $300,000 home, the first lien position loan generally has the larger loan amount. As an example, the first lien would be $240,000 or 80% LTV. The second is in a less superior position on title, you might have $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 of the remaining $30,000 or 10% LTV. Meaning by not borrowing over 80% LTV for your first, you avoid PMI.
How Does it Work?
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.
The Rule of Thumb
There are several options, but two of the most common are purchase money seconds, and standard second loans. What is the difference? Purchase money seconds comes from the seller. However, the lending institution finances the standard seconds.
For a standard second , if you secure funding from the same lender as your first loan, 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 loan.
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, the purchase money second has varying terms depending on the lender. Lenders may offer various terms, but usually they are shorter than the first loan. Secondsoften 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 initially might free up your cash initially, but keep in mind that second generally holds 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?
Avoiding PMI, as the PMI charge may be greater than the cost of a second. Therefore, a first lien that allows you to borrow 90% may be more expensive than an 80% first and a 10% second 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 (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 loans generally inherit all the risks as any other standard loan as well.
Purchase Money Second is 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 loan history may prove to be more difficult to obtain. Second liens call for a higher note rate than first lien positions. Therefore, the interest you pay can be significant over the life of the loan. A private loan 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 loan, 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
Besides the Purchase Second, there are other options. Assistance may help for your down payment. The state of Florida may have options that may fit your needs.
The various programs from State Housing Initiatives Partnership (SHIP) may be of interest to you.
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 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 loan you withdrew, not on the entire line.
PMI and a Second Liens
Each borrower has different circumstances. In some cases, it may be better to pay PMI rather than obtaining a Purchase Money Second. Loan insurance may go away once, however, a second 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 lien 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? 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 toward PMI, of course consult your CPA. Will you pay the loan down faster or make the minimum payments? If you make minimum payments, you may not eliminate PMI any faster and may benefit more from the second lien. If you make larger payments, though, you may request to drop PMI faster.
In Conclusion
The second purchase 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 loan is an acceptable way to get around it.
If you borrow 80% LTV on the home to avoid PMI, then this may cost you less in the long run. You can always consider refinancing the property if the value goes up later on. A great way to do this is by first calculating mortgage payoff then estimate your home value and see if you have 20% equity.
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. MortgageQuote.com can connect and discuss with you to go over your options. But 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.
The Ultimate Guide to Understanding Purchase Money Second Mortgages
In today's complex real estate market, buyers and sellers are exploring innovative options to finance their transactions. One such option gaining popularity is the purchase money second mortgage. But what exactly is a purchase money second mortgage, and how does it work?
In this comprehensive guide, we will demystify the world of ‘purchase money second mortgages’, providing you with all the information you need to understand this financing option. Whether you're a first-time homebuyer or a seasoned investor, this guide will equip you with the knowledge to make informed decisions.
From defining what a purchase money second mortgage is to exploring the benefits and considerations involved, we will cover it all. We'll also delve into the process of obtaining a purchase money second mortgage, including eligibility requirements and how it differs from traditional mortgage financing.
Understanding purchase money second mortgages can be the key to unlocking new opportunities in the real estate market. So, let's dive in and empower ourselves with this valuable knowledge.
What is a purchase money second mortgage?
In today's complex real estate market, buyers and sellers are exploring innovative options to finance their transactions. One such option gaining popularity is the purchase money second mortgage. But what exactly is a purchase money second mortgage, and how does it work?
In this comprehensive guide, we will demystify the world of ‘purchase money second mortgages’, providing you with all the information you need to understand this financing option. Whether you're a first-time homebuyer or a seasoned investor, this guide will equip you with the knowledge to make informed decisions.
From defining what a purchase money second mortgage is to exploring the benefits and considerations involved, we will cover it all. We'll also delve into the process of obtaining a purchase money second mortgage, including eligibility requirements and how it differs from traditional mortgage financing.
Understanding purchase money second mortgages can be the key to unlocking new opportunities in the real estate market. So, let's dive in and empower ourselves with this valuable knowledge.
How does a purchase money second mortgage work?
A purchase money second mortgage, also known as a seller or junior mortgage, is a type of financing that allows homebuyers to borrow additional funds to cover part of the purchase price of a property. Unlike a traditional mortgage, which is the primary loan used to buy a home, a purchase money second mortgage is a subordinate lien that is taken out in addition to the first mortgage.
The purpose of a ‘purchase money second mortgage’ is to bridge the gap between the down payment made by the buyer and the remaining purchase price of the property. It can be an attractive option for buyers who may not have enough funds for a large down payment or want to avoid private mortgage insurance (PMI) associated with low down payment conventional loans.
Benefits of a purchase money second mortgage
When a buyer obtains a purchase money second mortgage, the seller of the property agrees to provide a loan that is secured by a second lien on the property. The loan amount is typically a percentage of the purchase price, ranging from 5% to 20% of the total. This loan is then used to supplement the buyer's down payment, reducing the amount needed for the first mortgage.
The terms of a purchase money second mortgage can vary depending on the agreement between the buyer and the seller. Interest rates, repayment terms, and other conditions are typically negotiated as part of the purchase contract. In some cases, the seller may require monthly payments, while others may structure the loan as a balloon payment due at a specified future date.
It's important to note that the availability of purchase money second mortgages may vary depending on the real estate market and the willingness of sellers to provide this type of financing. It's always recommended to consult with a real estate professional or mortgage lender to determine the feasibility and availability of purchase money second mortgages in your area.
When to consider a purchase money second mortgage
1. Lower Down Payment Requirements: One of the primary benefits of a purchase money second mortgage is that it allows buyers to secure a home with a lower down payment. By borrowing additional funds from the seller, buyers can reduce their upfront cash requirements, making homeownership more accessible.
2. Avoiding Private Mortgage Insurance (PMI): Conventional loans typically require borrowers to pay for private mortgage insurance if they borrow more than 80% of the purchase price. With a purchase money second mortgage, buyers can increase their down payment and potentially avoid the need for PMI, resulting in significant cost savings over time.
3. Flexibility in Financing: A purchase money second mortgages offer flexibility in terms of loan repayment and interest rates. Buyers and sellers can negotiate the terms based on their specific needs and financial capabilities. This flexibility can be especially beneficial for buyers who are unable to secure favorable terms through traditional mortgage lenders.
Eligibility criteria for a purchase money second mortgage
A purchase money second mortgage may be a suitable financing option in the following scenarios:
1. Insufficient Down Payment: If you have limited funds available for a down payment, a purchase money second mortgage can help bridge the gap between your available funds and the purchase price of the property.
2. Desire to Avoid PMI: Private mortgage insurance can add a significant expense to your monthly mortgage payments. If you want to avoid this additional cost, obtaining a ‘purchase money second mortgage’ can increase your down payment and potentially eliminate the need for PMI.
3. Competitive Real Estate Market: In a competitive real estate market, where multiple buyers are vying for the same property, offering a purchase money second mortgage can make your offer more attractive to sellers. It demonstrates that you have additional funds available and are serious about purchasing the property.
Applying for a purchase money second mortgage
While the specific eligibility criteria for a purchase money second mortgage may vary depending on the lender and seller, there are some common factors that lenders typically consider:
1. Creditworthiness: As with any mortgage, lenders will assess your creditworthiness to determine your ability to repay the loan. A good credit score and a clean credit history will increase your chances of qualifying for a purchase money second mortgage.
2. Debt-to-Income Ratio: Lenders will also evaluate your debt-to-income ratio, which compares your monthly debt obligations to your monthly income. A lower debt-to-income ratio indicates a better ability to handle additional debt and may increase your chances of approval.
3. Property Appraisal: The property being purchased will be appraised to determine its value. This appraisal is essential for lenders to assess the loan-to-value ratio and ensure that the value of the property supports the loan amount.
Risks and considerations of a purchase money second mortgage
The process of applying for a purchase money second mortgage is similar to that of a traditional mortgage. Here are the general steps involved:
1. Research Lenders: Start by researching lenders who offer purchase money second mortgages in your area. Consult with real estate professionals or mortgage brokers to get recommendations and gather information about available options.
2. Gather Documentation: Prepare the necessary documentation, including proof of income, tax returns, bank statements, and identification. Lenders will require these documents to assess your financial situation and determine your eligibility.
3. Submit an Application: Complete the lender's application form and provide all the required documentation. Be prepared to provide additional information or clarification if requested by the lender.
4. Underwriting and Approval: The lender will review your application and documentation, conduct a credit check, and assess the property's value. If everything meets their criteria, they will issue a loan approval, subject to any conditions or additional requirements.
5. Closing and Funding: Once the loan is approved, you'll move forward to the closing process. This involves signing the necessary legal documents, paying any closing costs, and finalizing the loan. The funds from the purchase money second mortgage will be disbursed at this stage.
Alternatives to a purchase money second mortgage
While a purchase money second mortgage can offer various benefits, it's essential to consider the potential risks involved:
1. Higher Interest Rates: A purchase money second mortgages typically have higher interest rates compared to first mortgages. This is because they are considered riskier for lenders since they are subordinate to the primary loan. It's crucial to evaluate the long-term cost of the loan and determine if the benefits outweigh the higher interest rate.
2. Possible Higher Monthly Payments: Depending on the terms negotiated with the seller, the monthly payments for a purchase money second mortgage may be higher than those of a traditional mortgage. Buyers need to ensure that they can comfortably afford these payments while considering other financial obligations.
3. Limited Availability: Purchase money second mortgages may not be available in all real estate markets or in every transaction. Sellers may have their own financial constraints or preferences, making this financing option less common. It's important to explore alternative financing options and consult with professionals to understand the availability in your area.
Conclusion: Is a purchase money second mortgage right for you?
If a purchase money second mortgage is not a viable option for you, there are alternative financing options to consider:
1. Traditional Mortgage: A traditional mortgage is the most common method of financing a home purchase. It involves obtaining a loan from a lender, such as a bank or mortgage company, to cover the majority of the purchase price. Traditional mortgages offer a wide range of loan options and terms to suit different needs.
2. Government-backed Loans: Government-backed debt, such as FHA or VA loans, provide financing options with more flexible eligibility criteria and down payment requirements. These loans are insured by the government, reducing the risk for lenders and potentially allowing buyers to secure favorable terms.
3. Down Payment Assistance Programs: Various down payment assistance programs are available at the state, local, and nonprofit levels. These programs offer grants, loans, or subsidies to help buyers cover their down payment and closing costs. Research the options in your area to see if you qualify for any assistance programs.