Protecting the 2nd Lienholder Position

7 Replies

I'm looking to get private money lenders to loan the down payment for my hard money loans (to do flips), but I'm wondering if that puts them at a significant risk. I'd like to know how I can best protect my private lenders.

I know that if a foreclosure happens, the 1st can wipe out the 2nd. This makes me wonder what's the point of "securing" a loan with 2nd (or more) position on a property. But I know a hard money lender that has put their money into a deal as a 9th... so they must have thought they'd at least get their money back.

Also, is the foreclosure process the only way the 1st can take control of a property (in case the deal goes south)? If I just had a single private money lender on a 1st, how easy is it for them to go through that process to acquire the property?

The senior lien is certainly in a better position than the second, however, the most important factor is the total loan to value. If the property is worth $100k and the first is for $45k and the second for $20k, then the total loan to value is 65% which would be safe for both lenders. To protect your private money second lender, you should have documentation specifying that the first lien holder must notify in writing, the second lien holder of any default. In the event if a default, the second could pay off the first or work with the first lien holder to prevent getting wiped out in a trustee sale.

I think a wrap note works for this.  The wrap holder collects the payments from the borrower and disburses payments to the 1st lien holder.  If the borrower stops paying, the wrap holder must continue to pay the 1st lien holder and may foreclose on the borrower to take over the property.  As long as the wrap holder keeps the 1st lien holder current, the 1st cannot foreclose.

Thanks for responding, guys!

@Will Barnard What would be the max LTV you would have on a deal to protect your lenders? In the Seattle area, numbers are a little bit tight, so my target max is about 75%. Right now I'm considering doing a deal with 3 lien-holders (1 hard money, 2 private) at 72% total LTV. Does this sound pretty risky?

@Neil Aggarwal  I have never of a wrap note holder for hard/private money before.  Where can I find someone who will do the wrap note?  Will hard money lenders actually allow this?

But isn't this also the same problem?  You have someone who isn't the 2nd lienholder (my private lender) foreclosing on the property.  Whether it's the 1st or some other third party, doesn't the 2nd and subsequent ones still get wiped out?

Originally posted by @Nghi Le :

But isn't this also the same problem?  You have someone who isn't the 2nd lienholder (my private lender) foreclosing on the property.  Whether it's the 1st or some other third party, doesn't the 2nd and subsequent ones still get wiped out?

If the 1st lienholder forecloses, all subsequent leins will be wiped out.  That is why the wrap has to pay the 1st no matter what. 

A Wrap has nothing to do with this situation.  A wrap is given by an Owner, in a sale when extending a loan above that of the underlying first mortgage.

No need to do a wrap - if the first position isn't being paid the second can always put up money to cover paying the first. Now, some HML lenders do not permit a second loan to be made so that they don't have to deal with anybody but the borrower.

So maybe the best way to protect a second position lender is to escrow some number of payments intended to cover paying the first, and letting some third party make those payments from the escrowed funds. 

And to clear a misconception that I think I detected. If the second forecloses, the first is unaffected - the first lien stays in place; but if the second forecloses, the third and more junior liens are extinguished. 

Originally posted by :

Thanks for responding, guys!

What would be the max LTV you would have on a deal to protect your lenders? In the Seattle area, numbers are a little bit tight, so my target max is about 75%. Right now I'm considering doing a deal with 3 lien-holders (1 hard money, 2 private) at 72% total LTV. Does this sound pretty risky?

Typically, I don't have my lenders go over 70% LTV, however, there are a few cases where it has got ton closer to 75% and never above that. I think 72% is fairly safe in a strong market! but the LTV is not the only factor in risk, the borrower is. Since I have no details on the borrower, I can't comment on that and fully answer your question. From a straight LTV perspective, 72% is just barely over 70% so yes, safe in my book in the market today.

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