Forgivable second mortgages: how down payment help is paid back or forgiven

Forgivable versus deferred

Forgivable. The balance shrinks on a schedule, for example a fifth each year over five years, or all at once after a set period, as long as you meet the conditions. Once fully forgiven, you owe nothing.

Deferred. No payments are due, but the full amount is repaid when you sell, refinance or pay off the first mortgage.

Repayable. Monthly payments start right away or after a delay.

Some programs combine these. Read the note to see which you have.

What Fannie Mae requires

When assistance comes from an agency, nonprofit or employer program, Fannie Mae calls it a Community Seconds loan. Its Selling Guide sets the rules for the first mortgage it buys alongside one:

• Eligible providers include federal agencies, state and local governments including housing finance agencies, 501(c)(3) nonprofits, Federal Home Loan Banks, employers and certain tribal entities.
• Combined loan-to-value can go up to 105 percent with a Community Seconds loan.
• The first mortgage must be fixed-rate or an ARM with an initial fixed period of five years or more, on a one- to four-unit principal residence.
• The second must be fixed-rate, and its rate cannot be more than 2 percentage points above the first mortgage's rate.
• Repayment can be fully amortizing, interest-only, deferred or forgiven over time, at the provider's discretion.

If repayment is required, the second cannot come due before the earlier of 15 years after the first mortgage's note date or the first mortgage's maturity.

Effect on your debt ratios

Fannie Mae's rule is helpful for deferred seconds. When payments are deferred for five years or more, the lender does not need to count a payment in your debt-to-income ratio. If payments are deferred for less than five years, the lender counts the payment that will start after the deferral. Forgivable seconds with no payment due usually fall into the first group, but ask your lender to confirm.

What to check before you sign

The schedule. Is forgiveness gradual or all at the end? A cliff at year five means selling in year four could cost the full amount.

Repayment triggers. Sale and refinance are common. Some programs also require repayment if you move out or rent the home.

Refinancing. You may need the program's permission to keep the second in place, called subordination, if you refinance later.

Disclosures. The CFPB notes that some assistance loans come with Truth-in-Lending disclosures instead of a Loan Estimate and Closing Disclosure. Read whatever documents you receive with the same care.

Tax questions. Ask the program or a tax professional whether forgiveness has any tax consequence for you.

The bottom line

A forgivable second can turn assistance into a gift if you stay long enough. Know the forgiveness schedule, the repayment triggers and how your lender counts the loan. Then decide whether your plans match the program's timeline.