What Is a Purchase Money Second Mortgage?

A mortgage is a loan secured by real estate, enabling individuals to acquire property. While many are familiar with the primary mortgage used for home acquisition, this article clarifies the nature and function of a specific financing option: the purchase money second mortgage.

Understanding a Purchase Money Second Mortgage

A purchase money second mortgage is a loan obtained to finance a portion of a property’s purchase price, closing simultaneously with the primary mortgage. “Purchase money” means the loan proceeds are directly applied to acquiring the home. It is a “second mortgage” because its lien position on the property is subordinate to the first mortgage, meaning the primary lender has a senior claim to the property in the event of default or foreclosure.

Lien position dictates the order in which lenders are repaid from the sale of a property if a borrower defaults. A first mortgage holds the primary claim, and any remaining funds after its repayment go towards satisfying the second mortgage. This subordinate position means the second mortgage lender assumes greater risk, which influences the loan’s terms. Unlike a home equity loan or a Home Equity Line of Credit (HELOC), which are often taken out against existing home equity after purchase, a purchase money second mortgage is an integral part of the original home buying transaction.

Common Applications and Structure

Borrowers often utilize a purchase money second mortgage in specific scenarios to facilitate a home purchase. One common application is to avoid Private Mortgage Insurance (PMI), which is generally required on conventional loans when a borrower puts down less than 20% of the home’s purchase price. By structuring the financing with a first mortgage covering 80% of the home’s value and a second mortgage for an additional portion, a borrower can achieve an effective 20% down payment without contributing the full amount in cash. This arrangement is frequently referred to as a “piggyback loan,” with common structures being 80/10/10 (80% first mortgage, 10% second mortgage, 10% cash down payment) or 80/15/5.

This financing strategy allows individuals with limited down payment funds to enter homeownership or acquire a more expensive property. The two loans are established simultaneously as part of a single transaction at closing. Both the first and second mortgages are secured against the property, with the second lien positioned behind the first.

Financial Implications and Servicing

A purchase money second mortgage carries distinct financial characteristics. Interest rates on second mortgages are typically higher than those on first mortgages, reflecting the increased risk for the second lien holder, as their claim is subordinate to the primary lender in a default scenario. These loans can have fixed or adjustable interest rates, and their amortization schedules are separate from the first mortgage.

Borrowers with a purchase money second mortgage make two separate monthly payments: one for the first mortgage and another for the second. It is possible to have two different lenders or loan servicers managing these distinct loans. Managing two mortgage payments can impact a borrower’s overall debt obligations and monthly housing costs, which is reflected in their debt-to-income (DTI) ratio. This ratio, which compares monthly debt payments to gross monthly income, is a factor lenders consider for loan qualification.

If the first mortgage is fully paid off, the second mortgage does not automatically assume the first lien position. While it becomes the primary outstanding lien on the property, its terms, including the interest rate, remain those of a second mortgage due to its initial risk assessment. Borrowers might consider refinancing the remaining second mortgage balance into a new first mortgage for more favorable terms once the original primary loan is satisfied.