Buying a 2nd lien note with owner in bankruptcy

Tax Liens & Mortgage Notes
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Buying a 2nd lien note with owner in bankruptcy

Han Oh
Laguna Niguel, CA · Member since 2015 · 71 posts · 29 votes

I am in contact with a 2nd position private lender who is willing to sell his note at a small discount. The property is in California, the sale date is scheduled for mid December and he is the foreclosing lender. There is a 1st in place which was previously in preforeclosure but that has issued notice of rescission and I can't find any default notice since then. The current owner has filed for bankruptcy about a month ago and the 2nd position lender is saying that he is in the process of getting a release of stay from the court which should happen pretty soon. I do not yet have information on whether it is a Chapter 7 or 13 bankruptcy as I have yet to make more detailed contact with the lender. There is plenty of equity in the house.

I'm thinking about purchasing the note from the lender after bankruptcy is lifted and taking over his foreclosure process. 

Being this my first note purchase experience, what are the risks and potential complications that could arise from this? If the bankruptcy was filed just one month ago by the owner, why would the court grant the release so soon especially if there is a payment plan in place, and can the 2nd position lender request for the release? Can the court order the 2nd lien to be reduced or even relinquished due to the owner being in bankruptcy? Do I run any risk of losing part or all of my investment?

I sincerely appreciate all of your responses in advance.

Happy Thanksgiving!

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Joshua Andrews
Lender · Austin, TX · Member since 2012 · 211 posts · 166 votes
10y

Hi Han,

There is nothing wrong with buying a loan in this condition. A few things you need to be clear on prior to purchasing. I am sure there are others but these immediately come to mind.

1. Find out the 1st mortgage payment amount and if it's current or in default.

2. Determine how much equity is really in the property. Be conservative and account for resale fees, legal, and other expenses. These can add up fast.

3. Find out what type of bankruptcy are they in.

4. Get the borrowers first and last name, and last four digits of their social. Go to pacer . gov and look up their BK filing. Learn everything you can about that situation and what has been filed. It is all available virtually for free at pacer.

5. I would also ask for a hefty discount in a situation like this. I realize the property has equity and is in California, which is a non judicial foreclosure state, but you should still be buying with a hefty discount, not a slight one. Regardless of the outcome you will be laying out money or waiting months before a resolution is realized. I am not saying this is a bad deal, just something to be aware of.

Since all you stand to gain is what is owed on the 2nd lien, you should be buying at much less than what it's worth. That difference between what you paid and what they owe on the 2nd lien is your profit. Your risk or exposure is having to extend legal fees and possibly carrying the 1st mortgage until you can sell the property once you have taken legal ownership through a foreclosure via the 2nd lien.

Here are my responses to your questions below in ITALICS.

QUESTION: Being this my first note purchase experience, what are the risks and potential complications that could arise from this? 

ANSWER: Many things could arise. It could still be a good deal if you have all the information up front. I would suggest getting a title report to start with.

QUESTION: If the bankruptcy was filed just one month ago by the owner, why would the court grant the release so soon especially if there is a payment plan in place, and can the 2nd position lender request for the release?

ANSWER: A payment plan for debts will only be in place on a Chapter 13 bankruptcy. A chapter 7 will have no payment plans to many creditors. I don't have all the information to comment on why the stay would be lifted quickly. You need to find more information on the filings via pacer.

QUESTION: Can the court order the 2nd lien to be reduced or even relinquished due to the owner being in bankruptcy?

ANSWER: No. 2nd liens cannot be stripped or "wiped" in California. The bankruptcy could potentially stall your being able to foreclose or recover your investment for a good deal of time though.

QUESTION: Do I run any risk of losing part or all of my investment?

ANSWER: In almost all situations, the answer is yes. If you cannot afford to lose the money I would not suggest purchasing. However, this could be a solid deal. We don't have the actual figures here in order to make an informed decision. There are a great deal of nuances here. I would suggest having someone with more experience guide you on a purchase like this and not trying to do it yourself. Or, simply start with a more vanilla note purchase with a defaulted 2nd lien.

Hope that helps.

Josh

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    10y
    Originally posted by @Boyd McClean:

    The Supreme Court has recently ruled that the second can not be wiped out if under water.

    Right now I have a car note paying 92% yield that I bought. Had a GPS installed so if the payor is late then by my iPhone I disable his ignition. I then no longer have payment problems.

    That ruling has t do with the value but the court still can do what is referred to as a "cram down" reducing amounts that have nothing to do with the value of the collateral or dismiss it entirely for non-compliance.

    Next, if you're renting the car, good for you, if you're simply a secured creditor, it's unlawful collection practice, you're basically denying use. Wait till some check is lost in the mail and your borrower has an emergency, or you strand them on a highway! Not a good tactic. :) 

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    10y

    @Bill Gulley  the gps chip and disabling the car for non payment is used for Poor credit risk folks I know major car dealers who do this..  Not sure the realities or risks but I know it happens

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    10y
    Originally posted by @Jay Hinrichs:

    @Bill Gulley  the gps chip and disabling the car for non payment is used for Poor credit risk folks I know major car dealers who do this..  Not sure the realities or risks but I know it happens

     Oh, I'm sure it does happen, wait until someone crashes or someone dies because they couldn't get mom to a hospital, see how negligent homicide or reckless endangerment stacks up to an unlawful repo or bill collection tactic. 

    Poor people have poor ways, you don't see many paying for attorneys. It's when they get a free attorney is when predatory types need to pay attention.

    I financed a car long ago in the Army, sold to a civilian. Guy was late, he moved, was hiding out, at that time I was in aviation. I spread the word I was looking for my car, the pilots flew a search and rescue practice mission and they found my car at a house in the country! 

    I drove over, knocked on the door, the guy answered, I'll never forget the look on his face! How did you find me????  At that moment, a pilot was in a Huey overhead, I just pointed at him and said I have friends! He couldn't believe it, after some words, I got the keys and drove off!  We didn't have GPS then, LOL. :)   

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  • Account Closed
    Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes
    10y
    Originally posted by @Dion DePaoli:

    In California a foreclosure can be done non-judicially or judicially.  In order for a Mortgagee to seek a deficiency against the borrower the foreclosure must be judicial.  The common foreclosure is non-judicial but judicial actions still take place.  

    A deficiency is the amount due by subtracting the auction proceeds from the total due.  Nothing to do with BK directly but can be affected by BK - as a discharged debt can not have a deficiency sought.  

    I posted the California code.  After doing some digging for clarity when a Deed of Trust is used in California the borrower has an equity of redemption (pre-sale) which expires 5 days prior to sale.  Also refereed to as "Reinstatement Period".  

    After a judicial proceeding which does not seek a deficiency California requires the 3 month right of redemption.  If the judicial proceeding does seek a deficiency then the borrower has a one year right of redemption.  

    In both of those judicial settings, oddly enough, it looks as if the borrower can retain possession until the termination of the time.  A bidder at auction is barred from filing writ for possession.  In other words, they can not be evicted in that setting until the redemption period runs it course.

    So my statement above is incorrect - the 3 month period is for judicial proceedings that do not seek deficiency.  Not sales relying on the Power of Sale in a deed of trust.  

    The BK stays all collection efforts.  The second lien filing for relief of that stay will probably not be granted until a plan is approved and a failure to address the second lien's payment fails.  Could take a couple months from initial filing.  

    So, no right of redemption after a trustee's sale.  Felt pretty confident about that.  Did not know there was any right of possession allowed post judicial sale, but it does make sense given the right of redemption. Good stuff to know.  More interesting to me is why a lien holder would seek a judicial foreclosure if they weren't seeking a deficiency judgment.  The only thing I can think of is when they are forced to seek a judicial foreclosure based on a promissory note or other mortgage instrument that did not include power of sale.  

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  • Patrick Desjardins
    Real Estate Investor · Amherst, VA · Member since 2015 · 386 posts · 400 votes
    10y
    Originally posted by @Boyd McClean:

    The Supreme Court has recently ruled that the second can not be wiped out if under water.

     Just picked up on this. This is somewhat incorrect.

    They ruled that a 2nd mortgage can't be stripped in a chapter 7 BK, which was only done in the 11th Circuit.

    Based on BoA vs Caulkett they shouldn't be able to strip in BK13 but it might take a long time before it's challenged and enforced. 

    You would need to get your lien stripped in BK13 and then appeal it all the way to the Supreme Court - or wait until one of the big banks does.

    You can raise that defense for sure but the attorneys I've spoken to mentioned that BK judges are mostly going to keep doing what they were doing until they're forced not to.

    If you want an in depth article I wrote on this subject:

    https://www.linkedin.com/pulse/boa-vs-caulketts-potential-impact-chapter-13-lien-patrick-desjardins

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  • Chet Mazur
    Flipper · Cupertino, CA · Member since 2015 · 265 posts · 27 votes
    10y

    I have been thinking as I am in the same boat.. What is you offer the borrower for a deed in lieu or cash and a deed in lien. I have a call in to see if that's let in CA.

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  • Account Closed
    Investor · Princeton, TX · Member since 2014 · 1k+ posts · 1k+ votes
    10y
    Originally posted by @Han Oh:

    @Wayne Brooks

    I have nothing to lose in that case except that my return on money would not be as attractive. 

    I could not let this go.  If not done correctly, it could be a total loss.

    1)  You need insurance to cover the loss of the property as soon as you buy the lien.

    2)  The lien could be ruled invalid in Federal or State court.

    3)  You must have the ability to pay the first lien in full when the note gets accelerated.

    4)  The property could actually be worth much less than you pay for it.

    5)  It could take years with little or no money coming in before you get a dime.

    Don't get me wrong, I am not saying this is a bad deal at any price.  You just have to know there is risk.

    Since you are not a creditor, I would suggest contacting the property owners directly.  You might be able to find out what they have in mind and possibly work a deal out with them.

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  • Chet Mazur
    Flipper · Cupertino, CA · Member since 2015 · 265 posts · 27 votes
    10y

    | Also refereed to as "Reinstatement Period".

    (and I was advised )Unless there is and acceleration/dye on sale close. The full amount can go to sale. There is special language in the NOD and I think NTS as well.

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