Using a Family Second Mortgage Alongside Bank Financing: What to Know Before You Try

By Timothy Burke, National Family Mortgage ®
For informational purposes only; not tax or legal advice.

Executive Summary

Families often assume that helping with a home purchase means either fully financing the property or making an outright gift. In practice, many families fall somewhere in between. A parent may not want to fund the entire purchase price but may be comfortable providing part of the financing, similar to situations where parents loan money to their children to buy a house–often enough to bridge a down payment gap, avoid private mortgage insurance, or reduce reliance on high-cost bank debt.

In those cases, a family second mortgage, used alongside a primary loan from a commercial lender, can be an effective structure. When documented properly, this approach allows families to combine institutional financing with private family support while maintaining tax compliance and clear expectations.

For minimum-rate compliance in related-party mortgages, see IRS AFR Compliance for Intra-Family Loans and Seller-Financed Home Sales.

This article explains how family second mortgages work, why they are often misunderstood, and what families should consider before attempting this structure.

What Is a Family Second Mortgage?

A family second mortgage–often referred to as a piggyback mortgage–is a loan made by a family member that is secured by the home and recorded in a subordinate lien position behind a bank’s first mortgage.

From a legal and tax perspective, the structure is straightforward:

A commercial lender provides the primary mortgage.
A family member provides additional funds as a loan.
The family loan is documented with a promissory note and secured by a recorded mortgage, deed of trust, or security deed.
The borrower makes two monthly payments–one to the bank and one to the family lender.

This arrangement is distinct from gifting money for a down payment and distinct from co-ownership. The family member acts as a lender, not an owner.

Why Families Use Family Second Mortgages

Avoiding Private Mortgage Insurance (PMI)

Many buyers face higher costs when borrowing more than 80% of a home’s value. Banks often require PMI in these situations, increasing monthly payments without building equity.

By combining:

an 80% primary mortgage from a bank, and
a family second mortgage covering part of the remaining balance,

families can often eliminate PMI entirely while keeping overall borrowing costs lower.

For many families, the appeal of a family second mortgage is not leverage, but risk management, particularly when compared with informal assistance.

Reducing Dependence on High-Rate Debt

In rising-rate environments, families may prefer that a portion of the financing remain within the family at a more modest rate rather than pushing the borrower into a larger institutional loan at higher cost.

Preserving Structure and Fairness

Unlike informal assistance, a documented family second mortgage preserves clarity:

repayment expectations are explicit,
the transaction is visible in public records, and
the arrangement can be administered consistently over time.

A Common Source of Confusion: “Borrowing the Down Payment”

One of the most frequent problems families encounter arises from language rather than substance.

From a mortgage-underwriting perspective, down payments cannot be borrowed. They can be gifted, but they cannot be characterized as loans used for the down payment itself.

A family second mortgage is not “borrowing the down payment.” It is subordinate financing–a separate loan secured by the property and disclosed as such. When framed correctly, this distinction matters.

Mischaracterizing a family loan as a gift–when repayment is expected–can blur the distinction between a family loan and a gift.

These distinctions matter most when families are working under time pressure during a purchase.

Will Banks Allow a Family Second Mortgage?

Sometimes yes. Sometimes no.

Most institutional lenders recognize subordinate financing in principle, including loans from family members. In practice, approval depends on the lender’s policies and risk tolerance.

Common lender considerations include:

Whether the family loan payment is included in the borrower’s debt-to-income ratio.
Whether the family mortgage is properly documented and recorded.
Whether the structure increases perceived repayment risk.

Some lenders resist family second mortgages not because they are prohibited, but because they complicate underwriting or secondary-market saleability. This resistance is often operational rather than legal.

Families should be prepared for additional documentation requests and should expect that the primary lender will review the family loan terms.

Tax and Documentation Considerations That Still Apply

Adequate Stated Interest

Family second mortgages are subject to the same federal rules governing related-party loans. The promissory note should generally charge at least the Applicable Federal Rate (AFR) in effect for the month the loan is made, matched to the loan’s term.

Failure to charge adequate interest can result in imputed interest and unintended tax consequences for the family lender, even when the loan is in second position.

Proper Security and Recording

A family loan intended to function as a mortgage should be secured by the property and recorded with local real-estate authorities. An unsecured promissory note does not provide the same legal leverage or tax treatment.

Recording also clarifies priority, enforceability, and deductibility–particularly important when multiple liens exist on the same property.

Consistent Payment Behavior

As with any intra-family loan, payment behavior matters. Regular payments, accurate records, and consistent reporting reinforce the reality that the arrangement is a bona fide loan rather than informal assistance.

Practical Tradeoffs Families Should Expect

While effective, family second mortgages are not friction-free.

Families should anticipate:

Additional review by the primary lender.
The need to explain the structure clearly to real estate agents and loan officers.
Two monthly payments rather than one.
Coordination among settlement agents, lenders, and family members at closing.

These tradeoffs are often acceptable when weighed against long-term savings, reduced PMI costs, and retained family control.

When a Family Second Mortgage May Not Be the Right Fit

A family second mortgage may be impractical when:

the primary lender refuses subordinate financing outright,
the borrower’s debt-to-income ratio cannot support two payments, or
the family’s assistance is better treated as a true gift for tax or estate reasons.

In those cases, families may explore alternative structures or adjust expectations before proceeding.

Frequently Asked Questions

Is a family second mortgage legal?
Yes. When properly documented and disclosed, a family second mortgage is a recognized form of private financing.

Does the family loan have to be reported to the bank?
Yes. Subordinate financing must be disclosed. Attempting to conceal a family loan can create serious problems.

Can the family loan be interest-only?
In some cases, yes. The loan terms should still meet federal interest requirements and reflect a genuine repayment obligation.

Does the family lender need to appear on the property title?
No. The family lender acts as a lender, not an owner. Appearing on title changes the nature of the transaction.

Conclusion

A family second mortgage can be an effective way to combine institutional financing with family support–particularly when the goal is to reduce costs, avoid PMI, or keep part of the financing within the family.

Success depends less on creativity and more on clarity: clear documentation, clear disclosure, and alignment with both lender expectations and federal tax rules. When those elements are in place, families can structure layered financing that works for everyone involved.

Technical Appendix: Key Concepts

Subordinate financing refers to a mortgage that is junior in priority to another lien.
Applicable Federal Rates (AFRs) establish minimum interest benchmarks for related-party loans.
Imputed interest rules may apply when loans are written below required rates.
Recording statutes govern lien priority and enforceability under state law.

About the Author

Timothy Burke is the founder of National Family Mortgage ®, an online company focused on helping families document and support compliant intra-family mortgage loans and seller-financed home transactions. His work focuses on proper documentation, alignment with applicable federal tax rules, and practical implementation considerations for families and their professional advisors navigating private family financing.

Families and their advisors should consult applicable statutes, regulations, case law, and professional guidance when applying these principles to specific transactions.