Raising Second Position PML

[Kwok Wong]

Looking for some advice from experienced private money lenders , borrowers and investors.

I’m raising funding for a fix-and-flip deal. The property is already being financed by a hard money lender.

I found a potential private lender, but after reviewing the structure, he decided not to move forward because:

• The hard money lender does not allow second-position liens.
• He believes recording a second mortgage without the HML’s consent could violate the loan agreement.
• He said the only structure he would consider is cross-collateralization with another property.

For those of you who regularly raise private money:

1. How do you typically structure funding when the HML prohibits second-position liens?
2. Is cross-collateralization the most common solution, or are there other structures you’ve successfully used?
3. Have you obtained written consent from an HML for a second-position lien? If so, which lenders have been willing to do that?
4. If you were the borrower, how would you approach this situation?

I’m looking to learn best practices and understand how experienced investors handle this. Thanks in advance for any insights!

[Jeff S.]

It’s unenforceable.

Despite the conventional wisdom, and what many loan documents say, a senior lender cannot call a default because its residential (1-4 unit) borrower takes out a second or any other junior/subordinate loan. Nor does the borrower have to ask for permission.

Of course, the first-position lender does not have to make the loan if it knows the borrower's intent. Once made, however, these loan terms are unenforceable unless the property is commercial (5+ units). It does not matter whether the loan is a business-purpose or consumer-purpose loan.

Our loan documents, which we get from Lightning Docs, require the borrower to ask for written permission to obtain a loan subordinate to ours. We do not/cannot enforce this requirement for the 1-4 unit flip loans we make. The clause is there to enable the documents to be used for commercial purposes, among a few other reasons. Plus, we just don’t care.

Not all lenders oppose subordinate loans. In fact, we encourage 2nds behind our loans. In the event of a default, junior lenders might pay off our first-position loan or possibly face getting wiped out in foreclosure. They are also a source of pressure on a defaulting borrower. As first-position lenders, we like that extra security and do not prohibit seconds behind our loans.

For the skeptical, here’s some background …

Lending attorneys, as our did, will cite the Garn St Germain Act, signed into federal law by President Ronald Reagan 1982. The reference is under 12 U.S. Code § 1701j-3 - Preemption of due-on-sale prohibitions:

“(d) Exemption of specified transfers or dispositions

With respect to a secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a , amay not exercise its option pursuant to aupon—

• the creation of a lien or other encumbrance subordinate to the ’s security instrument which does not relate to a transfer of rights of occupancy in the property;”

There are eight additional exemptions, but they don’t apply in this case.

(You can add this to the other popular myth that private lenders cannot lend on owner-occupied properties, another widely held but mistaken belief.