Private lending in 2nd position
Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes
Private lending in 2nd position
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Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
2y@Jarrod Ochsenbein
You are correct that if property has equity coverage you would get paid off in a foreclosure
Just realize what is loan for, if it’s fix and flip the property may not be fully renovated which add risk
It comes down to underwriting the borrower. There are no guarantees in life. We had a borrower who first three loans did great and this fourth one is in default (we are in first).
It’s unfortunate but it happens
7e investments53 Reviews
29 Replies
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes2y
@Jarrod Ochsenbein
You are correct that if property has equity coverage you would get paid off in a foreclosure
Just realize what is loan for, if it’s fix and flip the property may not be fully renovated which add risk
It comes down to underwriting the borrower. There are no guarantees in life. We had a borrower who first three loans did great and this fourth one is in default (we are in first).
It’s unfortunate but it happens
7e investments53 Reviews - Accountant · San Diego, CA · Member since 2019 · 1k+ posts · 552 votes2y
Jarrod, i would consider focusing on airtight around a personal guarantee. Ideally, if they have other properties, getting collateral on that as well.
- Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
Quote from @Chris Seveney:
@Jarrod Ochsenbein
You are correct that if property has equity coverage you would get paid off in a foreclosure
Just realize what is loan for, if it’s fix and flip the property may not be fully renovated which add risk
It comes down to underwriting the borrower. There are no guarantees in life. We had a borrower who first three loans did great and this fourth one is in default (we are in first).
It’s unfortunate but it happens
Thank you Chris. My current loan is for $45k on a property they picked up for $215k. As it sits it is worth around $280 ish and ARV is $340k according to me. The borrower is thinking $360, but either way I believe there is equity. The first lien is hard money.
- Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
Quote from @Account Closed:
Jarrod, i would consider focusing on airtight around a personal guarantee. Ideally, if they have other properties, getting collateral on that as well.
Thank you - Any other documents I should look into? The borrowers typically use an LLC on the docs and the personal guarantee is something I use just in case.
- Investor · Member since 2023 · 118 posts · 61 votes2y
Quote from @Jarrod Ochsenbein:
Quote from @Chris Seveney:
@Jarrod Ochsenbein
You are correct that if property has equity coverage you would get paid off in a foreclosure
Just realize what is loan for, if it’s fix and flip the property may not be fully renovated which add risk
It comes down to underwriting the borrower. There are no guarantees in life. We had a borrower who first three loans did great and this fourth one is in default (we are in first).
It’s unfortunate but it happens
Thank you Chris. My current loan is for $45k on a property they picked up for $215k. As it sits it is worth around $280 ish and ARV is $340k according to me. The borrower is thinking $360, but either way I believe there is equity. The first lien is hard money.
You don't mention the HM 1st amount. I wouldn't go above 65% CLTV, maybe less. By CLTV I mean (1st + 2nd)/Value. And make sure you have enough cash to bring the 1st current should it go into default. You don’t want your lien wiped off should the 1st go to foreclosure, and you don’t have cash to bring it current and start your own foreclosure. Equity is your friend, the more the better.
Research the 1st a little bit. Get the note and mortgage. Are the payments current. Does the 1st mortgage prohibit junior financing.
- Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
The 1st HM loan is for $247k on a $215K purchase. He added a construction hold back and other items.
- 2ySteve HodgdonPro MemberInvestor · Novato, CA · Member since 2015 · 432 posts · 321 votes
I learned the hard way that I need the capacity to make the first mortgage payments in the event of default. 2009-10 still stings.
- Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
Thanks Steve. In the event a default happens I could cover the $247K, but that would hurt. :) I am up to $400k and cautiously lending. I have loans out now and have $220k remaining. If something happened while other loans are out I would have to pull $27k from a Heloc to cover the difference. I am heading to a multifamily event in Washington in mid Jan. I hope to make more connections there to either lend or venture into the PMP space.
- Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes2y
@Jarrod Ochsenbein
That’s not a loan most people would do.
What state is this in?
If they default on the HML just recognize it probably has default interest around 20% and the fees add up quick.
What type of experience did this borrower have ?
7e investments53 Reviews - Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
15 properties and cleared an extensive background/portfolio check.
I am making assumption it's a hard money loan. It could have been a private money loan.
- 2yShiloh LundahlPro MemberRental Property Investor · Gilbert, AZ · Member since 2016 · 3k+ posts · 4k+ votes
I get second position notes for my properties all the time. I would say one of the things you want from the borrower would be the note on the first and evidence that payments are made each month. I would also say that there needs to be a cap on the first with regard to rehab draws. You wouldn't want the first and the second to go higher than 70 - 75% of the ARV.
Lastly, I would say that you need evidence of capital. Such as bank statements. Even if someone is funding a project 100%, you want to know that that person has the wherewithal to pay for any unforeseen expenses. You could have a minimum capital requirement to have in their accounts during the life of the loan. - Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
Shiloh Lundahl - Man this is gold. I probably shouldn't be investing as much as I have been. I am risking a lot, but I wanted to get into the game so to speak. Thank You, Thank You, Thank You.
I will add this to my lending check list.
Jarrod
- 2yAlex BreshearsBusiness MemberLender · Springfield, MO · Member since 2020 · 351 posts · 504 votesMy concern with being in 2nd lien would be the hard money loan. Many of those loans don’t allow junior liens - so if your lien is discovered and they send the borrower a notice of default (because they broke one of the rules of their financial agreement) - then they may have a very short time to repay your lien (if they can). Since these lenders are very asset focused - and with so much equity in the deal - they could push for foreclosure just because there is a junior lien. How likely is that to happen depends on how close the lender is following their portfolio. I would also be added to the hazard insurance as an additional loss payee/mortgagee and have a lenders title policy for every transaction as a way of further protecting yourself. I’ve lent in the 2nd lien position several times but it’s a very tight buy box - and I will absolutely not do it behind a HML. That’s just my risk tolerance tho - yours may be different.
Quote from @Jarrod Ochsenbein:
Quote from @Chris Seveney:
@Jarrod Ochsenbein
You are correct that if property has equity coverage you would get paid off in a foreclosure
Just realize what is loan for, if it’s fix and flip the property may not be fully renovated which add risk
It comes down to underwriting the borrower. There are no guarantees in life. We had a borrower who first three loans did great and this fourth one is in default (we are in first).
It’s unfortunate but it happens
Thank you Chris. My current loan is for $45k on a property they picked up for $215k. As it sits it is worth around $280 ish and ARV is $340k according to me. The borrower is thinking $360, but either way I believe there is equity. The first lien is hard money.
- Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
Quote from @Alex Breshears:
My concern with being in 2nd lien would be the hard money loan. Many of those loans don’t allow junior liens - so if your lien is discovered and they send the borrower a notice of default (because they broke one of the rules of their financial agreement) - then they may have a very short time to repay your lien (if they can). Since these lenders are very asset focused - and with so much equity in the deal - they could push for foreclosure just because there is a junior lien. How likely is that to happen depends on how close the lender is following their portfolio. I would also be added to the hazard insurance as an additional loss payee/mortgagee and have a lenders title policy for every transaction as a way of further protecting yourself. I’ve lent in the 2nd lien position several times but it’s a very tight buy box - and I will absolutely not do it behind a HML. That’s just my risk tolerance tho - yours may be different.Quote from @Jarrod Ochsenbein:
Quote from @Chris Seveney:
@Jarrod Ochsenbein
You are correct that if property has equity coverage you would get paid off in a foreclosure
Just realize what is loan for, if it’s fix and flip the property may not be fully renovated which add risk
It comes down to underwriting the borrower. There are no guarantees in life. We had a borrower who first three loans did great and this fourth one is in default (we are in first).
It’s unfortunate but it happens
Thank you Chris. My current loan is for $45k on a property they picked up for $215k. As it sits it is worth around $280 ish and ARV is $340k according to me. The borrower is thinking $360, but either way I believe there is equity. The first lien is hard money.
This is awesome advice and knowledge sharing Alex. I really appreciate you taking the time to enlighten me and others that may read this. This is such a great community!!!! :)
- Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes2y
Quote from @Alex Breshears:
Unless this refers to a commercial property (5 or more units), this is incorrect, @Alex Brashears. A lender cannot call a default if their residential (1-4 unit) borrower takes out a 2nd, 3rd, 4th, or any other junior/subordinate loan. That’s not to say that many residential loan docs don’t contain this language. And, the lender doesn’t have to make the loan if they know this is the borrower’s intent. Once made, however, these loan terms are unenforceable unless this is a commercial property. It doesn’t matter that it might be a business-purpose loan.
A Promissory Note, DOT, Personal Guarantee, and JV agreement are hardly overkill, @Jarrod Ochsenbein. But what’s the JV doing in there? Are you a lender or a partner? We get our complete loan doc package from a lending attorney, and you should too. If the state you are lending in requires a license, you should find someone with the appropriate credentials to originate the loan for you professionally. Don’t make things up on your own and, for heaven’s sake, don’t make your loan contestable. With due respect, since loan docs are state-specific, be careful asking here which documents you should use. Your lending attorney will know.
Last, even though you seem to have enough to make a relatively safe 1st position loan, if you insist on making a 2nd (???), the 1st position lender is now your best friend. Make sure you introduce yourself to them. (It amazes me how few 2nd position lenders actually do this with us even though we welcome the calls.) Ask about their background. What’s their loan mod/forbearance policy? Do they foreclose quickly? Do they have a construction arm and also flip houses? Will they call you first if there is an issue with their loan? Take heed of the answers. They could control the future of your loan.
- 2yAlex BreshearsBusiness MemberLender · Springfield, MO · Member since 2020 · 351 posts · 504 votesHi Jeff! Thanks for the input. I appreciate it. I am going off what my attorney has said and how our specific loan docs are written for first liens. That may very well be the case in a practical sense as a judge may just toss the case if the judge sees the mortgage is being paid on a timely fashion. I’ve also known a few lenders who build in a fee for waiving a stipulation in the loan agreement - so if they discover a second lien they could issue a small fee (one time or monthly) for allowing the borrower to be outside of their loan agreement. I personally don’t use this strategy.
Quote from @Jeff S.:
Quote from @Alex Breshears:
Unless this refers to a commercial property (5 or more units), this is incorrect, @Alex Brashears. A lender cannot call a default if their residential (1-4 unit) borrower takes out a 2nd, 3rd, 4th, or any other junior/subordinate loan. That’s not to say that many residential loan docs don’t contain this language. And, the lender doesn’t have to make the loan if they know this is the borrower’s intent. Once made, however, these loan terms are unenforceable unless this is a commercial property. It doesn’t matter that it might be a business-purpose loan.
A Promissory Note, DOT, Personal Guarantee, and JV agreement are hardly overkill, @Jarrod Ochsenbein. But what’s the JV doing in there? Are you a lender or a partner? We get our complete loan doc package from a lending attorney, and you should too. If the state you are lending in requires a license, you should find someone with the appropriate credentials to originate the loan for you professionally. Don’t make things up on your own and, for heaven’s sake, don’t make your loan contestable. With due respect, since loan docs are state-specific, be careful asking here which documents you should use. Your lending attorney will know.
Last, even though you seem to have enough to make a relatively safe 1st position loan, if you insist on making a 2nd (???), the 1st position lender is now your best friend. Make sure you introduce yourself to them. (It amazes me how few 2nd position lenders actually do this with us even though we welcome the calls.) Ask about their background. What’s their loan mod/forbearance policy? Do they foreclose quickly? Do they have a construction arm and also flip houses? Will they call you first if there is an issue with their loan? Take heed of the answers. They could control the future of your loan.
I do agree with reaching out to the 1st lien holder if doing a second just to get an idea of what those loan terms are since my loan would be junior to theirs. - Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
Quote from @Jeff S.:
Quote from @Alex Breshears:
Unless this refers to a commercial property (5 or more units), this is incorrect, @Alex Brashears. A lender cannot call a default if their residential (1-4 unit) borrower takes out a 2nd, 3rd, 4th, or any other junior/subordinate loan. That’s not to say that many residential loan docs don’t contain this language. And, the lender doesn’t have to make the loan if they know this is the borrower’s intent. Once made, however, these loan terms are unenforceable unless this is a commercial property. It doesn’t matter that it might be a business-purpose loan.
A Promissory Note, DOT, Personal Guarantee, and JV agreement are hardly overkill, @Jarrod Ochsenbein. But what’s the JV doing in there? Are you a lender or a partner? We get our complete loan doc package from a lending attorney, and you should too. If the state you are lending in requires a license, you should find someone with the appropriate credentials to originate the loan for you professionally. Don’t make things up on your own and, for heaven’s sake, don’t make your loan contestable. With due respect, since loan docs are state-specific, be careful asking here which documents you should use. Your lending attorney will know.
Last, even though you seem to have enough to make a relatively safe 1st position loan, if you insist on making a 2nd (???), the 1st position lender is now your best friend. Make sure you introduce yourself to them. (It amazes me how few 2nd position lenders actually do this with us even though we welcome the calls.) Ask about their background. What’s their loan mod/forbearance policy? Do they foreclose quickly? Do they have a construction arm and also flip houses? Will they call you first if there is an issue with their loan? Take heed of the answers. They could control the future of your loan.
Thank you for your information. Very much appeciated.
- 2yBeth JohnsonPro MemberLender · Renton, WA · Member since 2018 · 215 posts · 216 votes
I've built my private lending business around 2nd lien position loans - it accounts for roughly 45-50% of my loan volume. Here's some thoughts:
- Don't lend in 2nd position behind hard money or any short-term loan like construction loans. Even if you aren't gap funding, you could lose any equity stake with punitive default interest and also risk the HML calling the note due because they disallow 2nds without an intercreditor subordination agreement.
- On the subject of gap funding, just don't. There isn't any equity stake to protect your principal capital investment. So unless you add additional collateral from their SoRE, then don't do it. Period.
- Request and verify their schedule of real estate (SoRE). You need to understand how much their network is if you are going to request a Personal Guaranty. These PGs mean NOTHING without a high net worth and are only meant to be used in cases of deficiency - meaning the collateralized subject property doesn't have enough equity to make the creditor whole. It's what you would do AFTER a foreclosure proceeding, in most cases, not prior.
- Be sure you vet out the borrower's multiple exit strategies beyond resale. Do they have cash position to come to close in case they can't sell for what they owe? Do they have the ability to refinance or is the CLTV too high or their credit not great? Do they qualify for a DSCR loan with estimated market rents (use long term average rents, not suped up STR or MTR rental income to be safe). Can the property repay with cashflow (not typically looked at for SFR but for 2nds we do on properties like mobile home parks with super low LTV, we have to know they can pay off with property income and not a refi since most bank loans I've seen on these asset classes is closer to the 50-55% LTV mark.)
Just a few thoughts off the top of my head. There's a lot of ways to lose on 2nds but there is also a lot of ways to generate solid returns and higher interest yields with this strategy. In nearly 10 years of doing PML, we have a sub 3% default ratio with a near zero principal loss (lost 2K on 9-figures funded in my tenure, which isn't too shabby given our stance on junior liens.)
- Investor · Salt Lake City, UT · Member since 2019 · 339 posts · 126 votes2y
You could also buy the property and give them the option to buy it back, that way you have ownership(control).
- Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
Quote from @Beth Johnson:
I've built my private lending business around 2nd lien position loans - it accounts for roughly 45-50% of my loan volume. Here's some thoughts:
- Don't lend in 2nd position behind hard money or any short-term loan like construction loans. Even if you aren't gap funding, you could lose any equity stake with punitive default interest and also risk the HML calling the note due because they disallow 2nds without an intercreditor subordination agreement.
- On the subject of gap funding, just don't. There isn't any equity stake to protect your principal capital investment. So unless you add additional collateral from their SoRE, then don't do it. Period.
- Request and verify their schedule of real estate (SoRE). You need to understand how much their network is if you are going to request a Personal Guaranty. These PGs mean NOTHING without a high net worth and are only meant to be used in cases of deficiency - meaning the collateralized subject property doesn't have enough equity to make the creditor whole. It's what you would do AFTER a foreclosure proceeding, in most cases, not prior.
- Be sure you vet out the borrower's multiple exit strategies beyond resale. Do they have cash position to come to close in case they can't sell for what they owe? Do they have the ability to refinance or is the CLTV too high or their credit not great? Do they qualify for a DSCR loan with estimated market rents (use long term average rents, not suped up STR or MTR rental income to be safe). Can the property repay with cashflow (not typically looked at for SFR but for 2nds we do on properties like mobile home parks with super low LTV, we have to know they can pay off with property income and not a refi since most bank loans I've seen on these asset classes is closer to the 50-55% LTV mark.)
Just a few thoughts off the top of my head. There's a lot of ways to lose on 2nds but there is also a lot of ways to generate solid returns and higher interest yields with this strategy. In nearly 10 years of doing PML, we have a sub 3% default ratio with a near zero principal loss (lost 2K on 9-figures funded in my tenure, which isn't too shabby given our stance on junior liens.)
Thank you Beth
This is fantastic. I appreciate you taking the time to enlighten a newbie. I have done a few loans now and so far so good. I vet borrowers through a company, which the borrower pays for @ $2500 a pop. :) I am currently in a 2nd position loan where the borrower did use a HML in 1st position. I didn't realize they could have a stipulation that wouldn't allow 2nd pos loans. Moving forward I will add this to my list. This particular deal was acquired for $215k with hard money and I came in for $45k. The ARV per the borrower was $360k and I estimated it @ $340k. The borrower is sound and has 10 properties in his portfolio with half of them with decent equity. He has done about 15 flips in the past 7 years. It looked like a pretty solid deal, so I went for it. The reno is just about done and it looks marvelous. The should be going to market soon and we are all interested in it selling well.
- Member since 2020 · 4 posts · 2 votes2y
Quote from @Beth Johnson:
I've built my private lending business around 2nd lien position loans - it accounts for roughly 45-50% of my loan volume. Here's some thoughts:
- Don't lend in 2nd position behind hard money or any short-term loan like construction loans. Even if you aren't gap funding, you could lose any equity stake with punitive default interest and also risk the HML calling the note due because they disallow 2nds without an intercreditor subordination agreement.
- On the subject of gap funding, just don't. There isn't any equity stake to protect your principal capital investment. So unless you add additional collateral from their SoRE, then don't do it. Period.
- Request and verify their schedule of real estate (SoRE). You need to understand how much their network is if you are going to request a Personal Guaranty. These PGs mean NOTHING without a high net worth and are only meant to be used in cases of deficiency - meaning the collateralized subject property doesn't have enough equity to make the creditor whole. It's what you would do AFTER a foreclosure proceeding, in most cases, not prior.
- Be sure you vet out the borrower's multiple exit strategies beyond resale. Do they have cash position to come to close in case they can't sell for what they owe? Do they have the ability to refinance or is the CLTV too high or their credit not great? Do they qualify for a DSCR loan with estimated market rents (use long term average rents, not suped up STR or MTR rental income to be safe). Can the property repay with cashflow (not typically looked at for SFR but for 2nds we do on properties like mobile home parks with super low LTV, we have to know they can pay off with property income and not a refi since most bank loans I've seen on these asset classes is closer to the 50-55% LTV mark.)
Just a few thoughts off the top of my head. There's a lot of ways to lose on 2nds but there is also a lot of ways to generate solid returns and higher interest yields with this strategy. In nearly 10 years of doing PML, we have a sub 3% default ratio with a near zero principal loss (lost 2K on 9-figures funded in my tenure, which isn't too shabby given our stance on junior liens.)
If you aren't doing gap funding in 2nd position, what are you lending on? I'd be curious to know as I also did not see any mention of 2nd position loans on your website. Thanks! @Beth Johnson
- 2yBeth JohnsonPro MemberLender · Renton, WA · Member since 2018 · 215 posts · 216 votes
@Dustin Williams Sometimes it is pulling equity out of a rental and using to acquire more rentals or flips. Other times, capital is used for capex improvements with the idea that they would refinance afterwards. We do cross-collateralization with a 1st lien on the new property and a 2nd on a rental to cover more of the purchase price and possibly some of the rehab to allow for a BRRRR scenario. Our Flynn Family Lending website talks about our 2nds. My Lend2Live website is for passive capital investors and private lenders as opposed to being borrower focused!
- Rental Property Investor · Oregon/Arizona · Member since 2023 · 124 posts · 79 votes2y
I'm lending to my repeat borrowers on some of their paid off properties in first lien position.
- Lender · FL · Member since 2024 · 34 posts · 10 votes2y
Having multiple layers of protection is a smart approach to mitigate the risk of not being paid back in a 2nd position loan. Using a 2nd lien on the target property or cross-collateralizing with another property can provide security in case of default. A JV agreement and a promissory note outline the terms and responsibilities clearly, ensuring that both parties understand their obligations. Personal guarantees add an extra level of commitment from the borrower. While it may seem like overkill to some, these measures can provide peace of mind and safeguard your investment.
- 2yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Quote from @Jarrod Ochsenbein:
Quote from @Jeff S.:
Quote from @Alex Breshears:
Unless this refers to a commercial property (5 or more units), this is incorrect, @Alex Brashears. A lender cannot call a default if their residential (1-4 unit) borrower takes out a 2nd, 3rd, 4th, or any other junior/subordinate loan. That’s not to say that many residential loan docs don’t contain this language. And, the lender doesn’t have to make the loan if they know this is the borrower’s intent. Once made, however, these loan terms are unenforceable unless this is a commercial property. It doesn’t matter that it might be a business-purpose loan.
A Promissory Note, DOT, Personal Guarantee, and JV agreement are hardly overkill, @Jarrod Ochsenbein. But what’s the JV doing in there? Are you a lender or a partner? We get our complete loan doc package from a lending attorney, and you should too. If the state you are lending in requires a license, you should find someone with the appropriate credentials to originate the loan for you professionally. Don’t make things up on your own and, for heaven’s sake, don’t make your loan contestable. With due respect, since loan docs are state-specific, be careful asking here which documents you should use. Your lending attorney will know.
Last, even though you seem to have enough to make a relatively safe 1st position loan, if you insist on making a 2nd (???), the 1st position lender is now your best friend. Make sure you introduce yourself to them. (It amazes me how few 2nd position lenders actually do this with us even though we welcome the calls.) Ask about their background. What’s their loan mod/forbearance policy? Do they foreclose quickly? Do they have a construction arm and also flip houses? Will they call you first if there is an issue with their loan? Take heed of the answers. They could control the future of your loan.
Thank you for your information. Very much appeciated.
what state are you making these loans in ... there are license requirements in Oregon and AZ. I suspect you have no license.. WA you need no license. States will have a carve out for a few like 2 or 3 from your IRA and that your not holding yourself out as a lender which it appears you are.. CA you need a license as well same with Nevada.. So it does matter were you making these loans.
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