Morby Method: How the DSCR Loan + Seller Second Stack Really Works

The Morby method is a creative-finance stack where a buyer uses a DSCR (or conventional investor) loan for most of the purchase price, usually 75% to 80%, and the seller carries back a second note for the down payment, so the buyer brings little cash to closing. It only works legitimately when the first-position lender knows about the seller second, approves it, and the combined loan amounts fit that lender’s CLTV limit.

The structure was popularized by Pace Morby, and it gets pitched as “no money down.” In practice the buyer still pays closing costs and must show reserves, and most DSCR programs cap combined financing well below 100%.

How the Morby method stack is built

It’s a commercial-style capital stack applied to a rental house: after closing, a bank or non-QM lender sits in first position and the seller sits in second.

1. Negotiate price and terms with the seller. The seller agrees to take part of the price as cash at closing and the rest as a promissory note secured by a second-position mortgage or deed of trust.
2. Get a first loan underwritten on the property. Usually a DSCR loan, which qualifies on rent instead of your income, covering roughly 70% to 80% of the price.
3. Disclose the seller note to the lender up front. The lender decides whether it allows secondary financing, how much (its CLTV limit) and on what terms.
4. Close once, with everything on the settlement statement. The first loan pays off the seller’s existing mortgage, the seller receives the remaining cash, and the seller note is recorded behind the new first lien with a subordination agreement.

Because the seller’s old loan is paid off at closing, there is no due-on-sale clause exposure on that loan. That is the main structural difference from subject-to, where the old loan stays in place.

The DSCR formula lenders use

DSCR stands for debt service coverage ratio. For residential investor loans, lenders typically define it as gross monthly rent divided by the proposed PITIA (principal, interest, taxes, insurance and association dues). AD Mortgage’s current DSCR matrix (updated August 2026) states it as “Gross Rental Income / Proposed PITIA.” A 1.00 ratio means rent exactly covers the payment; many programs price best at 1.20 to 1.25 or higher.

A worked Morby method deal, start to finish

HYPOTHETICAL deal: a three-bedroom single-family rental. The seller, a tired landlord, owes $140,000 on an existing mortgage and will carry part of the price. All figures are illustrative, not current rate or rent quotes.

Item	Hypothetical figure
Purchase price	$300,000
DSCR first loan (80% LTV)	$240,000, 30-year fixed, 7.25%
Seller second (20%)	$60,000, 3% interest-only, balloon due in year 7
Seller’s existing mortgage payoff	$140,000
Property taxes	$3,600 per year ($300/month)
Insurance	$1,800 per year ($150/month)
HOA	None
Market rent	$2,900 per month
Combined loan-to-value (CLTV)	100%

Note that 100% CLTV line. This version only closes if the lender has approved a seller second up to 100% of value in writing, which is uncommon. We’ll rework it under a stricter cap in a moment.

Monthly payments and the DSCR

• First loan P&I: $240,000 at 7.25% over 30 years = $1,637.
• PITIA on the first: $1,637 + $300 taxes + $150 insurance = $2,087.
• DSCR on the first lien: $2,900 / $2,087 = 1.39.
• Seller second payment: $60,000 x 3% / 12 = $150 (interest only).
• DSCR including the second: $2,900 / ($2,087 + $150) = 1.30.

The cash flow you actually keep

Both ratios clear a typical lender threshold. But lender DSCR ignores vacancy, repairs, capex and management. Your bank account does not:

Monthly line	Amount
Rent	$2,900
First loan PITIA	-$2,087
Seller second (interest only)	-$150
Vacancy (5%)	-$145
Repairs and capex reserve (8%)	-$232
Property management (8%)	-$232
Net cash flow	+$54

A 1.39 DSCR turned into $54 a month. One water heater wipes out a year of profit. Run every deal through a full expense model like net operating income, not just the lender’s ratio.

What the seller walks away with

• Gross price: $300,000.
• Minus the seller note: $60,000 (paid later, not at closing).
• Minus mortgage payoff: $140,000.
• Minus seller closing costs (hypothetical $6,000; title, recording and transfer taxes vary by state).
• Cash to seller at closing: $94,000.
• Later: $150 a month for 84 months ($12,600) plus the $60,000 balloon at the end of year 7.

The seller pitch: full price, a real check at closing, and interest on the rest. Show it on a draft settlement statement.

What “no money down” still costs the buyer

Even at 100% combined financing, the buyer in this example pays lender fees, appraisal, title, and prepaid taxes and insurance (call it a hypothetical $10,000), and many DSCR lenders require several months of PITIA in reserves. Six months here is about $12,500. That’s roughly $22,500 of liquidity for a “zero down” deal. Plug your own figures into the cash-on-cash return calculator to see what that cash actually earns.

The same deal under an 85% CLTV cap

Now assume a more typical lender: 75% max LTV on the first loan and 85% max CLTV including the seller second.

Item	100% CLTV version	85% CLTV version
First loan	$240,000 (80%)	$225,000 (75%)
Seller second	$60,000 (20%)	$30,000 (10%)
Buyer down payment	$0	$45,000 (15%)
First loan PITIA	$2,087	$1,985
Seller second payment (3% I/O)	$150	$75
DSCR on first lien	1.39	1.46
Monthly cash flow after reserves	+$54	+$231
Seller cash at closing	$94,000	$124,000

The approvable version needs $45,000 of buyer cash, but the seller gets more at closing and the cash flow is four times better.

The lender has to know about the seller second

This is the part most Morby method content skips. The seller second must be disclosed to and approved by the first-position lender: note terms reviewed, CLTV calculated, and the second shown on the settlement statement.

Why DSCR lenders push back on seller seconds

A DSCR lender relies on your equity cushion, and a seller second removes it. A 100% CLTV deal is underwater after any price dip, and a borrower with no cash in is likelier to walk away. So many DSCR programs either prohibit secondary financing on purchases, or allow it only under a CLTV ceiling (around 80% shows up often in published DSCR matrices), with a recorded subordination agreement and note terms they sign off on. Some also want sourced borrower funds in the deal and count the second’s payment in the DSCR. Get the answer in writing before signing a contract that depends on it.

Conventional investor loans: Fannie Mae’s subordinate financing rules

If the first loan is a conventional loan sold to Fannie Mae, Selling Guide section B2-1.2-04 (last updated August 6, 2025) governs the seller note. Key points:

• Disclosure is mandatory. Lenders must disclose the subordinate financing and its repayment terms to Fannie Mae, the appraiser and any mortgage insurer.
• It counts toward CLTV. All subordinate liens are included when calculating CLTV, regardless of who holds them.
• Payments must cover at least the interest. Negative amortization is not acceptable.
• No short balloons. A second that doesn’t fully amortize and balloons less than five years after the first mortgage’s note date is generally unacceptable.
• Below-market seller rates become a concession. If the seller’s rate is more than 2% below current standard second-mortgage rates, the financing is treated as a sales concession and deducted from the sales price.

Where a hidden second becomes mortgage fraud

Federal law makes it a crime to knowingly make a false statement to influence a lender. 18 U.S.C. § 1014 covers federally insured banks and any “mortgage lending business,” with penalties of up to $1,000,000 in fines, 30 years in prison, or both. States have their own mortgage fraud laws on top of that.

Tactics floated online to dodge lender rules are red flags, not hacks:

• Signing the seller note but recording it after the first loan funds so the lender “doesn’t see it.”
• Showing the lender a down payment from borrowed money that gets quietly returned after closing, then swapped for a seller note.
• Side agreements that never appear on the settlement statement.
• Answering “no” on the loan application to questions about other financing on the property.

The clean rule: anything the lender, title company or appraiser would want to know about the down payment’s source goes on paper before closing.

Dodd-Frank and the SAFE Act: investor buyer vs owner-occupant

A seller who carries a note is a lender. Whether consumer-lending rules apply depends mostly on whether the buyer will live there.

• Investor buyer, non-owner-occupied rental. Regulation Z exempts credit “primarily for a business, commercial or agricultural purpose,” and the official interpretation to § 1026.3(a) says credit to acquire rental property that is not owner-occupied is deemed business purpose. So the Truth in Lending rules, including the loan originator rules, generally don’t reach a seller second on a true rental. If the buyer expects to live there more than 14 days in the coming year, the property is treated as owner-occupied.
• Owner-occupant buyer (for example, a house hack). Now it’s consumer credit. Under 12 CFR 1026.36(a)(4) and (a)(5), a seller avoids being treated as a loan originator only if it fits an exclusion. The one-property exclusion (natural person, estate or trust, one financed sale in 12 months) requires no negative amortization and a fixed rate or an adjustable rate that can’t adjust for at least five years. The three-property exclusion adds that the loan must be fully amortizing and the seller must determine in good faith that the buyer can repay. Otherwise, use a licensed residential mortgage loan originator.

State licensing under the SAFE Act sits on top of this. The National Association of REALTORS summary notes the Act targets financing primarily for personal, family or household use and that states set the licensing details. A business-purpose loan to an investor is usually outside it, but confirm your state’s rules with the closing attorney or title company.

The balloon on the seller note

Most Morby seller seconds end in a balloon payment, and that is where the long-term risk lives. In our example, $60,000 is due at the end of year 7. You’ll pay it from one of three places: savings, a cash-out refinance, or a sale. A refinance only works if appreciation and paydown leave room under the new lender’s LTV limit. Flat values or higher rates in year 7 can leave you stuck.

Negotiate the longest term you can (seven to ten years), an extension option tied to on-time payments, and some principal amortization if cash flow allows. Avoid sub-five-year balloons.

What changes from state to state

Issue	Why it varies	What to check
Security instrument	Some states use mortgages, others deeds of trust	Which form the seller second uses (see deed of trust vs mortgage)
Seller’s foreclosure remedy	Judicial vs non-judicial foreclosure	How long the seller waits to recover if you default
Licensing for seller financing	States implement the SAFE Act differently and some add rules	Whether the seller or a note servicer needs a license, especially for owner-occupants
Usury limits	State interest-rate caps differ	That the seller note rate is legal
Transfer and recording taxes	Rates and who pays differ by state and county	Effect on seller’s net and buyer’s closing costs

Morby method vs subject-to vs pure seller financing

Factor	Morby method	Subject-to	Seller financing
Seller’s existing loan	Paid off at closing	Stays in place in seller’s name	Paid off, or the property is owned free and clear (or wrapped)
New lender underwriting	Yes, full DSCR or conventional approval	No	No outside lender
Due-on-sale risk	None on the old loan	Yes, lender can call the loan	None if no underlying loan; yes on a wrap-around
Seller cash at closing	Substantial	Usually small	Down payment only
Buyer credit needed	Yes, plus reserves	Little	Seller’s call
Key legal issue	Disclosure and CLTV approval by first lender	Due-on-sale and seller’s credit exposure	Reg Z/SAFE if owner-occupied buyer
Best fit	Seller with equity who needs a sizable check	Seller with low-rate loan and little equity	Free-and-clear seller who wants income

For the wider menu, including lease options and gap funding, see the guide to creative financing in real estate.

When the Morby method is the wrong move

• The DSCR is thin. If rent barely clears the lender’s ratio before vacancy, repairs and management, 100% financing turns a small setback into a monthly loss. Our example qualified at 1.39 and still netted only $54.
• The seller needs all cash. If the seller’s mortgage payoff plus their cash needs exceed what the first loan provides, there’s nothing left to carry. That’s a cash deal or a pass.
• The lender won’t allow it. If the loan officer says no secondary financing, or the CLTV cap leaves a gap you can’t fill with your own verified funds, the structure is dead. Don’t look for a way around the answer.
• The price only works because of the terms. A seller who will carry 20% at full asking may be pricing above market. Verify value independently.
• You have no reserves. One bad year can mean defaulting on two lenders at once.

Putting a Morby deal together the right way

1. Call two or three DSCR lenders and ask directly: do you allow seller-held secondary financing on a purchase, what is the max CLTV, and does the second payment count in the DSCR?
2. Underwrite with real expenses. If it doesn’t cash flow at 85% CLTV, it won’t at 100%.
3. Write the purchase contract with a financing contingency that names the seller note terms.
4. Have an attorney or investor-friendly title company draft the note, security instrument and subordination agreement.
5. Send the signed note terms to the lender and get written approval.
6. Close with the seller second on the settlement statement and record it immediately after the first lien.
7. Calendar the balloon refinance window two years ahead.

Morby method FAQ

Is the Morby method legal?

Yes, when the first lender knows about and approves the seller second and every document reflects the real terms. It becomes a fraud problem when the second or the true source of the down payment is hidden from the lender.

Is the Morby method really no money down?

Rarely. You still pay closing costs and show reserves, and most CLTV caps mean you bring some down payment.

Can a wholesaler use the Morby method?

A wholesaler can find and structure the deal, then assign it to a buyer with the credit and reserves to get the DSCR loan. The buyer, not the wholesaler, has to qualify and disclose the seller note.

What interest rate should the seller note carry?

Whatever you negotiate, within state usury limits. For conventional first loans, keep in mind Fannie Mae treats a seller rate more than 2% below market second-mortgage rates as a sales concession. Some DSCR lenders have their own rules, so ask.

What happens if I can’t pay the balloon?

You’re in default on the seller note, and the seller can foreclose on their second-position lien under state law. Negotiate extension options up front and plan the refinance years in advance.

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