2nd lien because borrower ran out of money

[Allison Collins]

Hi everyone! I've been reading a lot on the forums since discovering BiggerPockets from their lending book.  I read the book, but it didn't really cover this question. I have someone who wants to borrower money for a flip that went over budget.  He has a loan already on the property and needs additional capital. The book mentioned to secure it against real estate, but since this is a second mortgage, I wasn't sure what the process might be.  What should I know about second liens that may be different from 1st liens? Would I still go through a closing attorney to do this loan?

[Alex Breshears]

Hi Allison! I think I answered this question from you in a thread somewhere, but I'm happy to share this again.

For lending in the second lien position there are some different aspects to consider that aren't an issue when lending in the 1st lien position.

1. What is the first lien and what type of loan/lender has issued that loan? I will not lend behind a hard money lender.

2. Is the first lien current? I do not want to provide capital to keep the first mortgage current, it should be capital that goes into the improvements of the property.

3. Does the 1st lien holder allow 2nd liens? Some lenders do now allow junior liens, so making sure the 1st lien holder does is necessary. If they don't and a borrower moves forward with another lien, that may tip the 1st lien into default, even if it is current.

4. What is the combined loan to value they are seeking? I wouldn't stretch this too much. Right now 75% is the very top I would do, but everyone's risk tolerance is different. We are in a bit of a down turn in the economic cycle and several markets are seeing asset devaluation, while others are in the beginning stages of cooling off. The equity you thought was there might disappear sooner than expected.

5. How far along is the project and what will the money go towards? You will want to see what they have spent money on so far up to this point, and figure out why they are over budget or ran out of capital. Did they run into unexpected problems? Not figure in accurate costs? Poor time or money management? If they have significant over runs or the project is not near completion, this would likely not be a loan scenario I would want to lend on because the borrower is likely in over their head with the deal.

You would still run the loan through a closing attorney or title company.  You would still ask for lender's title insurance and an increase in the hazard insurance, as well as being added as a mortgagee/loss payee on the insurance as well.  If you choose to go forward with the loan, get the legal documents drawn up by an attorney familiar with lending in your state (or the state the property is located in if not the same state as you). I would also get a statement from the borrower declaring that they will not move into the property at any point, or allow a direct family member to move in. You want to keep this a non-owner occupied property to maintain a business purpose loan designation.