Supplemental Loan: A second mortgage placed behind your existing Freddie Mac first lien, allowing you to extract equity without refinancing. The supplemental is subordinate to the senior loan, and both loans must be serviced together with combined DSCR and LTV constraints.
When Does a Supplemental Make Sense?
You locked a 4.5% rate in 2021. Today's rates are 7%+. Your property has appreciated, your NOI has grown, and you need capital—but refinancing would mean:
| Losing Your Rate | Trading 4.5% for 7%+ increases debt service by 50%+ |
| Paying Prepayment Penalty | Yield maintenance or defeasance could cost $100K+ |
| Resetting Your Term | Starting over with a new 5-10 year loan |
A supplemental loan lets you tap your equity while keeping the original loan in place. You get new capital at today's rates—but only on the incremental amount, not your entire debt stack.
The Blended Rate Advantage: If you have $1.5M at 4.5% and add $300K supplemental at 7%, your blended rate is ~4.9%—far better than refinancing the entire $1.8M at 7%.
How Does Supplemental Sizing Work?
Supplemental loans are constrained by both LTV and DSCR—calculated on the combined debt stack:
Supplemental Sizing Example
Scenario: Property with $1,500,000 senior loan at 4.5%, current value $2,500,000, NOI of $175,000.
| Constraint | Calculation | Max Supplemental |
|---|---|---|
| LTV (80% max) | $2.5M × 80% = $2M total − $1.5M senior | $500,000 |
| DSCR (1.20x min) | $175K NOI ÷ 1.20 = $145.8K max DS; Senior DS = $91K | ~$400,000 |
| Binding Constraint | DSCR limits supplemental to ~$400,000 | |
The DSCR Squeeze: Higher supplemental rates mean higher debt service per dollar borrowed. At 7%, you need more NOI to support the same loan amount vs. your 4.5% senior. DSCR often binds before LTV on supplementals.
What Are the Supplemental Requirements?
Freddie Mac's Guide Section 5.10 governs supplemental loans. Key requirements:
| Requirement | Standard | Notes |
|---|---|---|
| Seasoning | 12 months minimum | Senior loan must be 12+ months old |
| Term Match | ≤ Senior remaining term | Supplemental can't outlive the senior |
| Combined LTV | 80% max (75% cash-out) | Same LTV limits as new origination |
| Combined DSCR | 1.20x minimum | Calculated on total debt service |
| Amortization | 30 years (or match senior) | Can match senior's remaining amortization |
| Prepayment | Matches senior structure | Usually yield maintenance or defeasance |
What's the Supplemental Process?
A supplemental requires full underwriting—almost like a new loan, but faster because the property and borrower are already in the system:
| Step | Timeline | What Happens |
|---|---|---|
| 1. Request from Servicer | Week 1 | Contact your servicer to initiate supplemental request |
| 2. Updated Financials | Week 1-2 | Current T-12, rent roll, borrower financials (Form 1115) |
| 3. New Appraisal | Week 2-4 | Updated Form 1025 appraisal required |
| 4. Underwriting | Week 3-5 | Combined DSCR/LTV analysis, rate lock |
| 5. Subordination Agreement | Week 5-6 | Form 1067 subordination executed |
| 6. Closing | Week 6-8 | Fund supplemental, record second lien |
Faster Than Refinance: Supplementals typically close in 45-60 days vs. 60-90 for a full refinance. The property is already in Freddie's system, reducing due diligence time.
What Is the Blended Rate Calculation?
Your effective cost of capital is the weighted average of both loans:
Blended Rate Example
| Loan | Balance | Rate | Annual Interest |
|---|---|---|---|
| Senior | $1,500,000 | 4.50% | $67,500 |
| Supplemental | $400,000 | 7.25% | $29,000 |
| Combined | $1,900,000 | 5.08% | $96,500 |
Compare this to refinancing the entire $1.9M at 7.25%: $137,750 annual interest. The supplemental saves $41,250/year.
The Blended Rate Trap: Don't just compare rates—compare total cost. If supplemental fees are 2% ($8,000) and you're only keeping it for 2 years, factor that into your effective rate. Short holds can make supplementals less attractive.
When Does Supplemental NOT Make Sense?
| Situation | Why Supplemental Fails | Alternative |
|---|---|---|
| Senior Rate Near Market | No rate savings to protect | Full refinance for better terms |
| Short Remaining Term | Supplemental capped at senior's remaining term | Wait and refinance at maturity |
| Value Declined | No equity to tap | No supplemental possible |
| NOI Declined | Combined DSCR won't work | Fix operations first |
| Need Maximum Proceeds | Blended rate limits sizing vs. fresh loan | Refinance if proceeds matter more than rate |
What Are the Costs?
| Fee | Typical Amount | Notes |
|---|---|---|
| Origination Fee | 0.75% - 1.00% | On supplemental amount only |
| Appraisal | $3,000 - $5,000 | Updated Form 1025 required |
| Legal/Processing | $5,000 - $10,000 | Subordination documentation |
| Title Endorsement | $1,500 - $3,000 | Second lien title insurance |
Total typical cost: 1.5% - 2.0% of supplemental amount. On a $400K supplemental, expect $6,000 - $8,000 in closing costs.
How Does the Subordination Work?
The Form 1067 Subordination Agreement governs the relationship between senior and supplemental loans:
| Payment Priority | Senior loan gets paid first in all scenarios |
| Default Rights | Senior can foreclose without subordinate consent |
| Cross-Default | Default on either loan defaults both |
| Modification Limits | Senior can't be modified without subordinate consent |
Same Servicer Advantage: Freddie Mac requires both loans be serviced by the same servicer. This simplifies payment processing and reduces coordination issues. Your monthly payment covers both loans.
What's the Prepayment Structure?
Supplemental prepayment typically mirrors the senior loan structure:
| If Senior Has | Supplemental Will Have |
|---|---|
| Yield Maintenance | Yield maintenance (same formula) |
| Defeasance | Defeasance (separate portfolio) |
| Step-Down | Matching step-down schedule |
The Prepayment Coordination: If you want to prepay the supplemental, you typically must prepay the senior too (or vice versa). The loans are tied together—you can't just pay off one and keep the other.
Supplemental Loan Checklist
- Confirm Seasoning: Is your senior loan 12+ months old?
- Calculate Equity: Current value minus senior balance = available equity
- Run Combined DSCR: Will NOI support both debt service payments at 1.20x?
- Compare Blended Rate: Is supplemental cheaper than full refinance?
- Check Remaining Term: Does senior have enough term left for your needs?
- Factor All Costs: Include fees, rate differential, and prepayment scenarios
The Bottom Line: A supplemental loan lets you tap equity without sacrificing a below-market rate. But it's not free money—you're adding debt service at current rates and reducing your DSCR cushion. Run the math carefully: sometimes keeping your rate is worth it, sometimes a clean refinance makes more sense.