Can I Sell a Second Note and Deed of Trust? The Perils of Subordinate Paper
When most people think of seller financing, they think of carrying a second. Buyer puts down 10% cash, gets a 75% traditional loan, and asks the seller to carry a 15% second. These deals can definitely help get real estate transactions closed and are a great tool for maximizing price point and creating liquidity in the marketplace.
If you’re the seller, though, just look at that second note and deed of trust as a bit of a gamble. If the payments come in, great! If they don’t, you’re walking away, because it’ll never be worth keeping a large 1st whole to protect a relatively small investment if things so south.
For that reason, no one will buy your note in the secondary market.
But look at it this way . . .
It was a gamble anyway. If you didn’t sell, holding out for the perfect scenario, depreciation and holding costs could easily have cost you another 10-20%. At least selling and carrying to get your price gives you the opportunity to collect and ultimately get what you want out of it.
Sometimes 2nds are negotiable . . .
- Buyers made large down payment at closing
- Payors have good credit scores
- Low CLTV (combined loan to value)
- Owner occupied
- Second that is no less than one-third of the underlying 1st (i.e. $50K 2nd:$150K 1st)
. . . but mostly they’re not.
I was recently looking at buying a 2nd that was stacked up crazier than usual.
An elderly couple had given a lease-option on 15 acres that was being used as a driving range (golf). When it came time to exercise the option, (purchase price much cheaper than the market value at the time), the couple had died, and the estate was left to deal with it.
The buyer didn’t have cash, so he exercised his option at the killer price through a private loan and asked the estate to carry back a second. Very creative on his part, but not great for the second note holder. Here’s what it looked like:
- Purchase price: $375,000
- Down payment: $0
- Credit score: unknown
- Property type: Commercial
- First note to private lender: $350,000
- Second seller carry back note to estate: $200,000
- No interest, no payments, just a balloon for $200K due in 2012
Does something look a little funny to you? Yeah, me too. The loans against the property total $550,000, but the sales price of the property was only $375,000. This goes way beyond negative amortization :-/
The estate felt OK about it though because it seemed like they were getting their money . . . the buyer used $175,000 of the $350K 1st loan to pay off the mortgage on his house (that was also held by this same estate). The estate felt like they got a down payment somehow.
I would be hard-pressed to even buy a partial of the first note, let alone any of the high-risk second. This estate could have used a little guidance at the point this transaction was being consummated. Gotta hand it to a very creative buyer, though! Wow! He really knows how to use his noodle!
One of the things I’m doing is helping people put their owner financing deals together at the time they’re actually coming together. If I’m involved in underwriting the buyer from the beginning, I can usually pay a lot more for any note that’s created.