Taking second position when lending out private money
Hey all! I've got a chance to lend to someone for a rehab project. They would like to use a different property (a well performing STR) as the collateral due to the renovation project being a rental property that is on the same lot as their primary residence. I would be taking second position on the STR property if I proceeded.
-Are there any issues with a loan for property 1 being secured with property 2?
-Also, how would I go about securing second position, go through a title company?
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#2 All Forums Contributor
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generally 2nd position is far riskier.
Risk being if everything goes south you will need to pay off the first to protect yourself.
U can mitigate this with a property that has substantial equity.
Also your rate of return should be adjusted for the added risk.. interest on seconds
tend to be 15 to 25% in the market place.
Thanks for that. They are also offering a personal guarantee by collateralizing future revenue form their various short term rentals. Thoughts on that instead?
We don't do it. The superior mortgage has clauses where interest, attorney fees, late charges, etc take precedence over your subordinate lien thereby pushing your CLTV position up. We won't do it unless the CLTV is super low.
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Quote from @Tyler McDonald:
Thanks for that. They are also offering a personal guarantee by collateralizing future revenue form their various short term rentals. Thoughts on that instead?
PG is good.. where people get in trouble with seconds is the following.
400k first mortgage
you loan them 50 to 100k in second position.
Something goes wrong and they cannot pay you and the first mortgage goes into default. Unless you have written POA from your borrower that you can talk to the first lender.. Most first lenders wont even talk to you if there is a default. So you want that document. You then have to step up and make the payments while you foreclose or you have to pay the first off in full to protect yourself.
So as long as you have a plan B and C to protect yourself then sure its fine. But if you using all your bullets in this loan and cant service or payoff the first your risking losing your entire loan.
PG are fine and all but if you have to invoke it means they are in trouble.. And a PG wont save you if they file a BK.. and it takes a court proceeding and a lot of money to collect on a PG.
Again I am just pointing out the risk factors you can talk to a RE attorney they will charge you some money and tell you the exact same thing.. this is why rates of interest on seconds is FAR HIGHER than first mortgages it prices for the substantial risk.
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@Tyler McDonald
We always get a personal guarantee on the borrowers. So if they have other assets we can attach to that.
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Quote from @Tyler McDonald:
Hey all! I've got a chance to lend to someone for a rehab project. They would like to use a different property (a well performing STR) as the collateral due to the renovation project being a rental property that is on the same lot as their primary residence. I would be taking second position on the STR property if I proceeded.
-Are there any issues with a loan for property 1 being secured with property 2?
-Also, how would I go about securing second position, go through a title company?
It all depend on CLTV position. And.... and the appraisal must be conservative enough. If CLTV is below 60% then it may be okay.
I see this question a lot and think it is far more to understand that the risk of a second position.
Somethings to consider are:
1). What is the value of the home and the value of all of the debt in front of it. For example, if the home value is $500K and the total of all of the debt in front of it is only $100K then it has a much different risk profile than if it has $400K worth of debt in front of it.
2). What is the personal financial position of the person you are lending to? Are they responsible around their life and personal finances? If so, it has a much different risk profile than someone who is always robbing Peter to pay Paul.
3). What is their experience in real estate / business / life? I see a lot of successful people get their "lunch" served to them in real estate. They have success in one part of their life and think that translates to real estate. In some instances it does and others it doesn't. I also know very experienced individuals that have a lifetime of experience but poorly manage their affairs. Their paperwork is sloppy, they don't use title, they don't use professional service firms to make sure things are setup properly, etc. This is a sign to me that there will be trouble ahead.
4). What is their track record? Do they have references or anything that helps you understand how they performed in the past?
I know this sounds like a lot to analyze for a "simple loan" but I can personally tell you horror story after horror story after helping thousands of individuals over the last 12 years.
You want to learn how to underwrite a deal / person correctly and eventually you will understand it and will be able to do it quickly and in a way that mitigates risk for you.