Hard Money Lender Prohibits 2nd Mortgage Position
Member since 2022 · 62 posts · 16 votes
Hard Money Lender Prohibits 2nd Mortgage Position
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Matthew CrivelliBusiness Member
Lender · MA · Member since 2021 · 1k+ posts · 1k+ votesThis is 100% normal, most HM lenders do not want anything to do with a second position on the note. This is because most of the notes are being sold after closing and nobody wants to buy a note with a second lien.
I would contact a RE attorney and ask for advice on the best course of action. I'm sure there are other ways to protect yourself.
Freedom Capital Funding, LLC523 Reviews
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- 4yMatthew CrivelliBusiness MemberLender · MA · Member since 2021 · 1k+ posts · 1k+ votes
This is 100% normal, most HM lenders do not want anything to do with a second position on the note. This is because most of the notes are being sold after closing and nobody wants to buy a note with a second lien.
I would contact a RE attorney and ask for advice on the best course of action. I'm sure there are other ways to protect yourself.
Freedom Capital Funding, LLC523 Reviews - Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes4y
You are correct. you could issue a personal loan with a personal guarantee and if they defaulted on you get a judgment. If they have other properties you could look to put the mortgage on another property. The risk you run is if they get multiple loans from multiple people like you and they get in trouble and file BK, it will be a race to the courthouse.
7e investments53 Reviews - Contractor · Scottsdale, AZ · Member since 2010 · 2k+ posts · 3k+ votes4y
The reality is that if there is a default, you probably won't have any security anyway if you're in a 2nd lien position.
A default on your friends deal is most likely to happen during the rehab portion of their project. Which means that the as-is value won't be enough to get you paid back, if they were to default while home was in construction/gutted.
You're taking a high risk position by just offering 2nd position debt. I'd try to structure it where you are a partner on this deal.
- Member since 2022 · 62 posts · 16 votes4y
Quote from @Scott E.:
The reality is that if there is a default, you probably won't have any security anyway if you're in a 2nd lien position.
A default on your friends deal is most likely to happen during the rehab portion of their project. Which means that the as-is value won't be enough to get you paid back, if they were to default while home was in construction/gutted.
You're taking a high risk position by just offering 2nd position debt. I'd try to structure it where you are a partner on this deal.
The plan is to sign a joint venture agreement which her hard money lender is requiring so they know where the remaining funds are coming from. Then, her and I plan to execute a promissory note so she is the guarantor.
When you say structure it so I am a partner, can you explain that further for me?
- Specialist · NJ · Member since 2022 · 1k+ posts · 649 votes4y
You two could've created an LLC together and negotiated equity in the deal for the money you are putting up and then you're not a debtor but an equity stake holder and don't have to worry about being paid back or being in a lien position. We do deals all the time where people are added to Operating Agreements because they bring something to the table like: Money, Credit Score, or Experience which allows for better terms on the loan.
- Member since 2022 · 62 posts · 16 votes4yI could still propose that. But how would that work if the deal goes sour and does not get the ROI he expects? I’d be a partner in an LLC that is in the red/underwater, no?
Quote from @Mike Klarman:
You two could've created an LLC together and negotiated equity in the deal for the money you are putting up and then you're not a debtor but an equity stake holder and don't have to worry about being paid back or being in a lien position. We do deals all the time where people are added to Operating Agreements because they bring something to the table like: Money, Credit Score, or Experience which allows for better terms on the loan.
- Member since 2022 · 62 posts · 16 votes4yBeth,
Quote from @Beth Johnson:
Quote from @Colby Burt:
Hi!
A friend is doing a BRRR to STR. Most of his money is coming from a hard money loan. The remaining amount is coming from myself, as a private loan. Her plan is to do a cash out refi and pay back the hard money loan and my loan.
Hard Money Loan is in 1st lien position. I asked to be in second lien position. Her hard money lender said they won’t allow anyone else to be on the mortgage as it is prohibited in the Hard Money Lender’s rules/policies.
Currently, I'd only be signing a JV agreement. But If I don't sign a mortgage with my borrower, I don't have any security in the event of a default.
Only thing I could do to have some sort of security is have her personally guarantee my loan which would allow me to foreclose on her personally/pursue her assets (including wage garnishment) in the event of default, right?Colby - A few things to consider from a private lender POV:
- Her exit strategy is to cash-out refi and pay off both loans but you would be paid last since the HML loan would be secured against the property and need to be paid off at the time of refinancing. What if the property doesn't appraise for the value she expects it to come in at? Keep in mind that rates are still rising and prices are steadily decreasing in many markets. You will have to decide as the lender if you feel comfortable or not with her exit because if she's not able to do a full C/O refi, then you will be stuck withe some money in the project that can't be paid out immediately. Then what would you both do? What other exits does she have? Will it pencil out to do a DSCR loan, if she can't get the STR loan with higher LTVs?
- If you decide to proceed with a JV agreement only, you may also want to consider having her sign/notarize a Deed of Trust (or another security instrument like a mortgage depending on where you live) that you can keep on hand but not record, so you aren't violating her junior lien issue with the HML. This will give you some security that you could record, if you had to. Though, you may be underwater with little to no equity as another commentor mentions, if the rehab isn't done properly or completed at all. Since you are basically gap-funding this deal, you aren't secured with ANY sort of equity buffer protection at all, rendering a 2nd lien position sort of useless in this instance since there isn't any protection. The only major benefit to being secured is helping her to do a rate and term refinance, which would be cheaper, with a higher loan balance on the property. And it also ensures you get paid out at the refi, rather than hoping she cuts you a check after it closes. But secured loans can be better than unsecured loans, in many cases.
- If you sign as a borrower on the mortgage, you are not securing your own principal capital investment as a lender. Rather, you are becoming a co-borrower on the loan which actually makes you liable for that HML loan, which you wouldn't want to do unless you are negotiating some sort of equity split and not just acting as a lender who gets interest income. I would not suggest trying to be a borrower without an equity split that incentivizes you for the added risk. You don't want to assume her financial liabilities as a lender only.
- A personal guaranty is only as good as the person's net worth. Going after one's primary home, in most cases, is extremely difficult with state's creating consumer and homestead protections so that people don't become homeless. And if your borrower has very little personal assets, then you could be suing with little to no return. I would caution from using a PG without really understanding her net worth or income potential. It could be a huge legal hassle that isn't worth it to you.
If you want to learn more about how to do private loans safely and securing, I have a BP blog that has some articles which may be helpful. Including how to do 2nd position loans in a safe manner.
Lend2Live: The Private Money Matchmakers (biggerpockets.com)
Thank you so much, and thank you to everyone past and future who will have responded.
I agree on your points:
She said if at refinance time the property does not appraise high enough, she’d pay me out of her cash reserved. But how do I know what those reserves are and how do I get her promise to repay in writing? I need a credit check, income verification and for her to sign a master promissory note to that effect.
Having a signed and notarized mortgage but not recording it is a great idea! Despite the property not being worth much during rehab, I love your point about having a mortgage allows me to be paid at refinance if she does a rate and term refinance.
Regarding me signing as a borrower, I fully agree and I also realized I wrote that wrong in my initial post. I will not be signing on as a borrower.
Thank you and everyone again so much. This forum is such an incredible resource.
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