Legal Question in Real Estate Law in California

First, I'm going to admit that I don't know the answer. I'm going to do some guesswork and some reasoning for you, which might be helpful.

If you are the mortgage lender, I'd say don't do it. This is classic "borrowing from Peter to pay Paul" and has no net effect on the borrower's overall indebtedness, although admittedly it could have an impact on his cash flow and ability to pay.

Next, I'd observe that there are many kinds of mortgage lenders, varying from government agencies to Uncle Ned, and including banks, savings and loans, credit unions, etc. Some of these operate under stringent regulations, others do not.

I'd also ask "whose qualifying criteria?" The mortgage lender's own? It seems idiotic for a lender to resort to such trickery to qualify a borrower under its own rules! On the other hand, if it is being done to meet someone else's qualifying rules, this little ruse seems like a fraud, if it is not disclosed to the other party.

Finally, there are several possible meanings for the word "legally" as used in your question. The mortgage lender may be violating a specific law that applies to it. The lender may only be breaking a policy rule of its money source, loan repackager or package buyer. Or, the side loan may simply be a fraudulent act that could result in a successful suit for damages if losses result and someone sues.

Maybe someone can give you a more specific answer, but it would probably be necessary to describe the parties and the transaction more particularly (but without naming names).