It’s not a rare thing for homeowners to take out a second mortgage such as a home equity loan or HELOC on their home. But, it is quite rare when homeowners start looking for “silent” second mortgages. What are these mortgages? And are they legal in Canada?
A silent second mortgage is a mortgage in the second loan position on a home, and the lender of the first mortgage is not aware of it. Always with second mortgages, all parties involved must be aware of the second loan agreement – including the first lender. So how, and when do these mortgages occur?
Silent second mortgages are most common when a homebuyer doesn’t have enough for their down payment. When sellers are particularly eager to sell their home, they may offer to loan the buyer the remaining money that they still need for their down payment. This loan arrangement, because it is a loan on the home and because a first loan would have already been applied for (and the process would most likely already be in progress), would be a silent second mortgage. These mortgages are not typically formal agreements because they could not be drawn up until the first loan was finalized and in place. Because of this, silent second mortgages are usually only a verbal agreement between the buyer and the seller. Typically the borrower must hide this second home loan from their first lender because the lender will determine the borrower’s repayment ability according to how much cash they put up front for the home.
If the homebuyer needed to borrow funds for their down payment, it’s an indicator that the buyer cannot afford the home and so, the first lender most likely would not approve the first mortgage.
Silent second mortgages are illegal in Canada for a number of reasons. Firstly,the original lender for the first mortgage must always be notified of any other loans on the property, even if they occur before the first mortgage is finalized. Silent second mortgages are also illegal because they are highly risky for the seller. Because there is only a verbal agreement, it can be difficult to prove that the loan was ever actually in place, and so the seller could end up losing their money with no recourse.
Perhaps the biggest reason why silent second mortgages are illegal is because they can lead to unqualified buyers buying homes that they can’t afford, which could ultimately lead to a housing crisis if too many people take them out at once.
