Investing in Second Mortgages
If you are considering putting your money in the real estate market, investing in second mortgages is a vehicle that can yield higher returns than first mortgage private lending, so if you have some funds to risk, a second mortgage investment can be quite lucrative. With this possible reward, of course, comes a higher level of risk as well. As you consider whether or not to put your money into a second mortgage, take a look at some of the potential downfalls — and some of the potential rewards.
Second mortgage investment risks
The primary risk that you take when investing in second mortgages is the position of your lien. When a home is sold, the first liability to be satisfied is any outstanding taxes. Then come mortgages, in the order of filing. So the first mortgage, which is generally the largest, must be paid first before the second, third and so on. In the event of a short sale, this can leave you in the lurch — consider the example of a house with $5,000 outstanding in taxes, $75,000 outstanding on the first lien and $50,000 outstanding on the second note (yours). The owner of the house is underwater and requests a short sale, which only brings in $60,000. $5,000 goes to the government, and $55,000 goes to the holder of the first mortgage, leaving $20,000 due on that one. You still haven’t gotten a dime on yours, and you don’t have an interest in the house, because you’re behind the first mortgage holder. (Second Mortgage Information – Investing in Second Mortgages)
Second mortgage investing
A creative solution to this is contacting that first mortgage holder and offering to bring that first loan current and then take it over. While the mortgage holder is not required to accept this, it is a more attractive option than foreclosure. If you have the funds on hand to bring that loan current and start making payments, you can take over the note and then either rent the house to the original owner or take it over yourself. Then you have a property of your own. This might not be as great of an outcome as getting the money back from your loan (plus interest), but it is an option when default happens.
Second Mortgage investing 101 – cont’
But what if the borrower is current on the first mortgage but is going into default on yours? It can be frustrating, because you may not be able to force a foreclosure on the basis of your own loan. These types of situations are known as “upside down liens.” If you granted a second mortgage for $25,000, but the borrower has only built up $5,000 in equity, you can’t foreclose and sell the whole Second Mortgage Investment Property for that full remaining balance.
This is usually happening for one of two reasons. If the borrower is actually current (not 30 days or 60 days in arrears) on that first loan, that means that he wants to stay in his home and has a source of money. If not, he wouldn’t be paying his mortgage payments each month. While you can eventually force your way to a short sale, it is often worth dealing with the borrower here. The likelihood is that he wants to bring your payment current as well, and he should be willing to put together an alternate payment plan. If you are willing to be a little flexible here with reporting to the credit bureaus, then you may be able to get back to current status on this loan more quickly than you think.
Another situation may be in play here, though, which is a fairly common experience for people investing in second mortgages. In this case, the borrower is working out a plan for loan modification with the first mortgage holder. At this point, you can step in and make things work out in your favor. If you think that the loan modification is a good idea because you can see that the borrower has improved his financial position (perhaps finding a new job or recovering from medical problems), you can step in and take on more of the debt. This does increase your risk, but it also increases your payoff when things turn around for the best.
If you are thinking about investing in second mortgages, give one of our experts at Amansad Financial a call or email. We will discuss your current situation and go over potential borrowers with you, tailoring a deal that will benefit you both. Follow the link below to get started Investing in Second Mortgages: