2nd lien private money risky?

Question

Hello everyone, I was presented a couple of opportunities to invest as a private money lender. It's either new construction or fix&flip. The thing is, both put me as 2nd lien in the note. I heard that 2nd tend to be risky with more reward. But I have no experience in deals like this. What are things that I should watch out for? And what are some exit strategy if it's fix&flip? How active/passive is such investment?

Jason Hirko · Answer

Not only are second positions risky, but they increase the risk of the first lien as you have decreased/eliminated the investors' skin in the game, so to speak. When the investor walks, the first lien holder is not worried about liquidating at a number that gets you your money back. I've only ever taken a second when the first was like 50% LTV and I was 25%, and even then that was only as part of a bigger strategy.

Darren Eady · Answer

You can either become a hard money lender yourself, which requires starting a company, website creation, legal assistance, program creation all to find yourself marketing a product that you have possibly little experience in, and potentially losing money for awhile . . . OR . . . you can work with a hard money lender that has been through all of that, knows what they are doing, and could use your funds to reimburse their loan money disbursed, and see if they will part with their performing mortgage notes.  It allows you to BE THE BANK without actually buying the bank!  Thanks!

Hanbin Y. · Answer

Account Closed Thanks for the advice. I looked up some articles. It seems 2nd lien is either earn it or lose it all. The thing is, my capital isn't big enough to spread into more than two 1st-position notes. For 2nd position, however, I can get 3-4 notes. Does this diversification (not really much) help a little?

Jeff S. · Answer

I completely agree with Account Closed Second position loans leave you exposed to being wiped out through a foreclosure by the first position lender.  I know you don't think it could happen to you now, but it happened to many who thought that in 2008.  With the real estate market currently overheating, and I'm guessing little experience on your part evaluating borrowers and their projects (?), it could happen to you. Can you afford that?

Yes, second position returns are typically greater than those in first position, but often not by much.  These loans are good for those with a lot of capital who can afford the (hopefully) occasional loss and can spread the risk over many loans to many borrowers on many projects. If you only have a small amount of money to loan you might instead consider participating locally in a fractionalized loan.

Fractionalized loans are typically for larger dollars and include several individuals as lenders on one note. Here a broker will accept smaller sums of money toward a specific deal from several investors. Each will have his or her name on a first position mortgage and note along with their percent ownership. The broker would normally control the relationships and might service the note.  These are legal in many, but not all states, and I don't know about NC. Real estate clubs are a good place to meet brokers and borrowers who use these loans.

Like any loan, I would only do this locally where I could meet and vet the broker and the borrower.  I would also visit the borrower's prior projects and verify his or her track record.  Not hard, yes a bit less profitable, but much safer than a second position loan.  Good luck, Hanbin.

Account Closed · Answer

Id rather do a high quality first than a bunch of questionable seconds.

Account Closed · Answer

I dont do second liens. In my opinion, as an individual lender, thats as good as no real security at all. Yes, theoretically you can foreclose or force the first mortgage to buy you out but there is also a high probability that the first takes the house and you get nothing in event of foreclosure. On the plus side, seconds are often for smaller amounts and pay higher rates so if you have the risk tolerance maybe you would do that. I personally dont do seconds.

Shiloh Lundahl · Answer

@Hanbin Y. After your research in 2nd position loans, what did you decide to do?  The reason I ask is because I am going to start creating performing 2nd position notes and I want to know what your experience was like so that I can have a better understanding when I approach investors with these types of notes.

Colleen Bigler · Answer

Colleen Bigler Lender in LA Ca.

While I agree with risk, the key is LTV. If I fund a 2nd  on case by case basis, I would not go above 55%.  However, doesn't work for point of purchase. More as cash- out refi on property owned, after the sale.

Hanbin Y. · Answer

@Darren Eady Great answer! My capital isn't large enough though to start my own HML business. I'll talk to some local hard money lenders. Thanks for the advice.

2nd lien private money risky?

Most Popular Reply