Second Mortgages

You may be asked to hold a second mortgage. (Or you may want to create a "wrap mortgage". Click here for an explanation of "wrap mortgage" and a discussion of it's benefits.)

The borrower is required to make payments on both the first and a second mortgage. It is even possible to have a third or forth mortgage.

However, the first mortgage, which becomes the first mortgage by being recorded at the county recorders office first, has priority in the event of mortgage foreclosure.

In fact, if the first mortgage holder (lender or mortgagee) commences a foreclosure action they will have their attorneys do a title search. They will discover who else has a legal interest in the property. They will foreclose the interest of any second mortgage holders.

What does this mean in plain English?

Assume the property is worth $100,000. There is a first mortgage of $80,000 and a second mortgage of $10,000.

You own the second mortgage. The borrower stops making payments on the first mortgage (or deed of trust). And the lender forecloses the loan. By the time this loan goes through the legal system, the first mortgage balance could now be $90,000 and the house is probably not in great shape. The house is sold by the court (or trustee depending on the state). 

You have the right to bid at the sale and pay off the first mortgage and keep the property. But would you want to? And someone else can bid on the property and if they bid enough, you will be next in line to get paid what is left after the first mortgage is paid off. (Up to the balance of what you are owed). But it's not likely to happen.

Another possibility is that you could keep the first mortgage current and foreclose your second mortgage. Most lenders will agree to this, but they may not be forced. to do this. Click here for the legal ruling on this subject.

So the chances are that you will get wiped out. 

Does this mean you should never make or own a second mortgage? Maybe. But commercial lenders do make second mortgage loans. PROVIDED the borrower has good credit AND a reasonable cash down payment has been made.

We recommend that you NEVER, NEVER take back a second mortgage if the buyer has not made a cash down payment.

Typically a second mortgage like the $10,000 above would sell for $5,000-7,000 if it is behind an $80,000 first mortgage and the property is worth $100,000. By comparison, the $80,000 first mortgage would probably sell for about $70,000.

There are some people who recommend that if you do give a second mortgage it should be for at least 50% of the value of the property. Let me explain what this means:

Scenario 1. House sells for $100,000. Buyer puts down $10,000. Buyer borrows $40,000 from the bank. Seller takes back 2nd mortgage for $50,000.

Scenario 2. House sells for $100,000. Buyer puts down $10,000. Buyer borrows $80,000 from the bank. Seller takes back $10,000.

These advisors prefer scenario 1 to scenario 2. They say, correctly, that if the buyer defaults, it is easier for you to make payments on a $40,000 first mortgage than an $80,000 first mortgage. Also that the larger second mortgage is more saleable if you choose to sell it for cash and the discount you take will be less.

My advise is, get all the cash you can up front. I'd sooner be faced with a write-off of a $10,000 mortgage than $50,000.

See also the special clauses we recommend you include when you give a second mortgage.

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Mortgages, owner financing, deeds of trusts, discounted mortgages, seller financed mortgage, hard money mortgage

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