2nd Mortgage Question answered - Posted by Ronald * Starr
Posted by Ronald * Starr on June 26, 2001 at 20:47:26:
There are several possible courses of action for the second loan holder. Virtually anything this person does will turn out good for him/her.
Probably this investor is buying the note at a discount. Almost surely, actually. It does not make sense to pay full face value for a “threatened junior” like this.
If you as the owner of the property bring the first and second current and keep them current, the holder of the second is holding a performing loan with a high return on the money paid for the note. The holder should be able to resell the note to some other investor for closer to full face value than the price s/he paid for it after a few months of good payment by you.
If you don’t pay either loan, the second could bring the first current, preventing the second from being wiped off the property. Then the second holder would demand repayment of the advances to pay the first and whatever else is owed to the second-holder. If you don’t pay off, the second holder can foreclose on the second and either of two – good – things will happen. Either somebody else bids on the property and the second holder gets back all of the money paid out for the cost of the foreclosure, the advances, and the delinquences of the second. Plus the Full Face Value of the second. Thus there is a profit: face value less the amount paid for the note. If nobody bids, the second holder gets the property and either holds it or resells it for full market value or something close. The third is probably wiped off–no longer is owed.
Suppose the second holder paid $8K for that $20K note and does the foreclosure, ending up with the $120K house with $80K loan on it. Paid how much? $80K (not out of pocket) + $8K (for note) +$4K or $5K to bring first current and foreclose = total of about $93K or $94K. Not too bad a price to pay.
Second could let the first go to sale and bid at the auction. If nobody else bids, the holder of the second gets the house for say $85K and the second loan is wiped off. Total price: $93K or so, all out of pocket. But this will happen sooner than doing his/her own sale. It is possible that the second holder could come after the property owner to get payment for the lost note. That is possible in CA, anyway.
If somebody bids against the holder of the second, everything over the amount owed to the first goes to the second loan – at least in CA. This may not be true in all states. So if the holder of the second gets the property, s/he is reinbursed for all the money over the amount of the first. At least if the property is bought for less than the combined amount of the first and second. I
f the bid gets up to the total of the first and the second, the holder of the second will probably let the other bidder get the property. Then the holder of the second will get paid off the face amount of the second, getting a profit, since s/he paid a discount for the second.
In fact, the second holder might stop bidding somewhere before the total of the first and second and just take what s/he gets from the sale to somebody else. Example: Property sells for $99K to some other bidder at the foreclosure of the first. First gets paid off $85K, second gets $14K, $6K greater than the $8K invested to buy the note.
If this took place 4 months after buying the second, this would an annulized profit return of $6K*3 divided by $8K = $18K / $8K = 225%. This is not the return earned, this is the annualized rate of return. Not bad for an investment, right? Better than banks are paying?
Another possibility is that the holder of the second can convince the property owner to deed the property over in lieu of foreclosure. Then the holder of the second might make a deal with the third, such as you mention you might do in your post, without telling the holder of the third that the foreclosure won’t happen because the second holder is now the owner and will pay up the first. So the holder of second gets the $120K property for $85K to the first (probably not out of pocket, maybe just make up back payments and expenses) plus the cost of the second note, $8K in our example, plus the cost of the third, say $1.5K as you mention. This is a total of about $93.5K, most of which is not paid out of pocket, since the first is left in place. Then go out and sell the property to a new buyer at market value.
The person investing in “distressed paper” who is sophisticated can make a lot of money. The person doing so, however, has to have plenty of resources to back them up. Note that if the second buys the house at the foreclosure of the first, it might cost about $85K to $100K cash. (At least in CA).
NOTE: this type of investing is for the person who knows what s/he is doing. I DO NOT RECOMMEND THIS FOR BEGINNERS.
Good Investing******Ron Starr************