How are 2nd mortgages priced?

Question

For example. Lets say you have a $100k house with a $90k first and a $10k 2nd mortgage. Borrower has an 800 FICO. The 2nd is at 10% interest only, balloon in 5 years. How much would a fresh note like that be worth? How much with 1 year seasoning?

I'm just trying to get a rough idea of how these things are priced.

Steve Hodgdon · Answer

Balloons often pop. During the crash I could buy an unsecured defaulted 2nd for 5 cents. Now its 75%. Doesn't take a giant correction to be out of the money. I'd have to like the house and be able to service the 1st.

Don Konipol · Answer

In illiquid markets, and markets lacking a central clearing structure, the answer is simply whatever a buyer and seller negotiate.  What we do on the buy side, is set a minimum return on our investment based on our perceived risk.  So the more (in our opinion ) negative factors in a particular note, the higher yield, or correspondingly deeper discount we require to engage our interest.

Your example is a second lien, at 100% total LTV, with little seasoning.  The one positive is the borrowers credit score.  This is actually somewhat similar to an unsecured personal loan, as to if the lender of the second isn’t paid he may elect to just eat the loss as the cost of foreclosure, make up back payments to the 1st lien holder, forceplaced insurance, back taxes, etc., would eat up any equity he had.

We only purchase commercial notes anymore, but on a note like your describing I’d be looking for a 25% annual return to account for the very high risks involved.  I believe the note offered would probably be too risky for most investors at any return.

Marco Bario · Answer

@Don Konipol gave you a good answer. I’ll add that if one were to use a servicer with such a low payment, the servicing fee would eat quite a bit of each payment. Normally I do as Don said and price based on the yield I need when considering the risk. But in this case my model would be different. I’d be more concerned with equity. I don’t think I’d pay more than $2,500 for the loan - and only because the credit score is strong. Another method is to buy the payments but not the balloon (a partial) which I’d still do at a discount but not as steep.

How are 2nd mortgages priced?

Most Popular Reply