In all real estate transactions involving a mortgage-which is most of them-all details of the transaction are recorded on a government form known as a HUD-1. A purchase can have more than one mortgage- the bank can loan a second (subordinate) mortgage, or in some cases, the seller can hold a second mortgage as well. In Westchester and metro New York, there are three lawyers at the closing table (buyer, seller lender) along with a title company. And if a second mortgage is permissible by the primary lender and all parties, it is recorded on the HUD-1 and everything is A-OK.
A silent second mortgage is mortgage that is not recorded on the HUD-1. It is considered a “side deal” and is typically a violation of RESPA (Real Estate Settlement Procedures Act). In other words, a silent second mortgage, or any other side deal that is not recorded on the HUD-1 for that matter, is often mortgage fraud.
The temptation to do a silent second mortgage occurs when there is a roadblock in closing a transaction and the parties are trying to avoid the pain of adapting to the circumstances. For example, suppose a house is priced at $400,000 and the seller agrees to a $385,000 sale price with a $10,000 seller concession back to the buyer to help defray closing costs. That would be a $395,000 contract price and the HUD-1 would reflect $10,000 back to the buyer and $385,000 net to the seller.
However, the house does not appraise for the $395,000, but instead only appraises for $387,000. The buyer still needs the $10,000 concession to pay their closing costs, and does not have the extra cash to make up the difference. The deal will therefore either die or the seller will have to absorb the $8,000 shortfall and net only $377,000. The seller is unhappy about this, and proposes to the buyer that instead of the $10,000 being a concession, that the buyer agree to pay back $8,000 to the seller as a second mortgage that is recorded after closing. They cannot put it on the HUD-1 because the mortgage does not allow for subordinate financing. The buyer might agree because they don’t want to lose the house. The seller is trying to avoid netting less money.
This is “fraud.”
While it may be tempting to grease a difficult transaction with a silent second or similar side deal, it can get all parties, including the lawyers and agents, into hot water. And no sale is worth jeopardizing one’s career for. To do the right thing, the buyer either has to get more money elsewhere or lose the deal, or the seller has to take less money. And as much as that stinks for either party, it sure beats losing your license. If something cannot be documented on the HUD-1, it should not be practiced.