Turning a 2nd lien into a 1st when selling the note?

Question

I am considering offering some owner financing on a property I am looking to sell. I currently have a first mortgage on the property so any note I create would be in 2nd position. I have two questions regarding this:

1) Can I even do this? Is there anything regarding the 1st note (which is held by a big-bank lender) that would prevent me from doing this?

2) Can I sell all or partial payments on the 2nd note with the agreement that all proceeds would first pay off the 1st lien so that the note moves into 1st position.

When trying to market this note to other potential buyers, can I specify in an agreement or something that within 14 days (or whatever short period it takes to send full payoff to the 1st lender) the 1st lien will be gone?

Any help here would be appreciated.

Dion DePaoli · Answer

Eyes that see like noses, we have.  I think Yoda said that once.

Bill Gulley · Answer

No, not really, it's that the circumstances as stated and lack of understanding of the applicable rules and structures lend to inadvertent screw ups that lead to predatory implications. Not that you're trying to mess over anyone on purpose, but it usually ends up that way when parties that are not informed in financing matters do things themselves. Rest easy there, if we thought you were intentionally being predatory, we'd say so.

Instead of hammering away at this CFD stuff, look to a straight note and deed of trust or a Sub-To transaction, instead. Search the topics and ask anything you like. Good luck :)

Bill Gulley · Answer

LOL, There is a higher level of sensory perception that comes with experience. The nose is usually correct.  :)

Dion DePaoli · Answer

These ideas of playing games with notes in order to reverse engineer a future value are often met with failure. A loan's value is not simply about how many payments they made on time. Nor are the additional influences a simple checklist.

What we seem to be able to pull from the two posts:
1. $50k pays off the current mortgage - plus
2. Property is being offered for sale at $73k. That doesn't mean it is worth $73k.
3. Selling for $73k. Taking back $65k in a mortgage and being happy to sell for $50k points more towards an inflated sale price or property value than it does a good loan.

The obvious question needs to be asked here. Why are you not selling the property in the open market for $73k or even $65k?

Why are you trying to go through all this hassle and complication to simply sell the property when it appears it would sell just fine and produce (provided your numbers are correct and fair) enough money to pay off the loan and put the same relative amount of money in your pocket?

Adding financing does not make the property more valuable.

The loan sale idea is a little confused. If you make a loan with a maturity in 36 periods. Hold that same loan for 12 periods. Then you are only selling 24 periods. Not 200 periods. The 36th period the entire balance is due. There is no 37th period. You are confusing Term with Amortization.

We can talk about what would be marketable return expectations from a future investor but we first would need to understand the risk in the loan. Making a bad loan clearly increases risk and risk increase discount and return expectations.

When planning or contemplating Seller Finance do not start with an anticipated discount. You will chase your tail. Good loans do not get discounted. They are good loans. That should be the endeavor (make a good loan) not an anticipation of a discount and then trying to out run it (making a bad loan).

As I re-read the second post it mentions an offer came in requesting these terms. Let me be clear, just because a [desperate] Borrower is willing to take on a bad loan does not mean a Seller/Lender should make the bad loan.

Perhaps if you share what the fair market value of the property is in your honest opinion and the relative balance of the underlying mortgage a better plan or idea may emerge than what is being tossed around thus far.

Geoffrey Lessel · Answer

Ok, thanks for the help guys. For the time being, I'm going to pursue other options.

Geoffrey Lessel · Answer

Are you guys suggesting that I am being predatory here?

Dion DePaoli · Answer

Geoffrey,

That clarity helps some.  The general plan here still has issues.  First let us start with the RE Value.  If the property has not sold after being on the market for $75k or more or what ever it was listed at, that sort of says that the property value perception here does not jive.  A properly priced property sells in the open market.  If/when it does not sell, the price is too high for some reason.The Buyer/Borrower is desperate in a loose sense.  They are seeking Seller financing at a high interest rate relative to where a conventional investment property loan would be.  So, the mere act and willingness to pay more is an illustration of desperation.  Perhaps they will not qualify for conventional financing.  Usually the case.  Does not make them bad.  Just understand the motive.  I am sure there is a story under the hood.Just to contrast that one step further.  The ideal buyer, for both their sake and yours, walks up to you with cash of a little over $50k or $60k (not sure where you floor number is) and they get a property with lots of equity and you get your net cash.  If the net cash is the end goal, all these steps in the middle is just unnecessary complication.  A property sold with a large chunk of equity already ingrained in the price should sell extremely quickly.While I have faith that complex things can be done properly sometimes, I tend to prefer to rely on assuming that complex things more often get screwed up.  The Sub2/Wrap is really for your benefit only.  A future note investor could look at the structure and really just realize they are actually a new creditor on the scene.  Their capital satisfies the current underlying senior mortgage which you owe.  Interests in the property and the debts are intertwined.  Frankly, for their own risk mitigation it would likely be best for them to just make a new loan and remove the [all] loan(s) you made altogether.  Clean and simple.  Ultimately, this is future refinance all dressed up and made complicated.  If you think about it that way, perhaps you can see you want a future potential investor to underwrite the borrower like you did.  The 'hope' is that the future note buyer can accommodate you preconceived discount by agreeing to the underwriting you did or did not due to their standards.  While you plan to carry that hope into the future you also hope the borrower pays as agreed and that no defects are created in origination of the Sub2 or any on-going debt service of either of the two mortgages.  So the 'plan' is hope squared.  Just to play devils advocate at one more level.  Let's assume you make the Sub2/Wrap.  Let's then think about what happens when the senior mortgagee files for foreclosure based on due on sale.  Then you need to go to market and sell the loan to another investor so their capital can  payoff the demand.  The Borrower you have is not obligated under your senior mortgage, you are.  You can not force your Borrower to refinance.  Failing to deal with that properly can cause you liability to your Borrower.  So, this leaves a sale of your note as your only viable option.  Want to guess what a discount looks like when it is clear that you are backed into a rock and hard place?  Pretty safe to assume you will not be walking away with any type of gain.

Bill Gulley · Answer

A contract for deed DOES NOT avoid the due on sale, it triggers the right to call the loan.

A contract for deed is NOT assigned as a note and deed of trust, they are different animals.

No one with a brain would buy a CFD as they would a note. They will buy the property subject to the existing contract and have that contract assigned. Otherwise, if the buyer sold or met the terms of the installment sale that new note/contractor would not be in a position to transfer title as they would not be in title. You must hold title before you can convey title.

A note holder does not convey title, that is already held by the borrower, the note holder has a lien and upon full payment they release the lien.

Yes, 10% has been around for decades as the AR usury. Might double check as to that usury law as being applicable to institutional loans, for registered lenders, which an individual is not. Banks could not charge more than 10%, such laws have been changing with the SAFE Act/Dodd-Frank bitter pill taken by institutions and have been modified allowing higher rates for such lenders.  MO. has had similar issues, individual seller financed deals for equity loans are still 10% here, so might double check. Thanks for the update.

I agree with Dion, just do a straight up sale or Sub-To if you must, you really need to see a local RE attorney. Good luck :)

Edited, posted before the last OP post. Dion, I still smell predatory, using Zillow, coming out 10k more, house won't sell at market, etc. LR is a spotty area, NLR even more so. :)

Geoffrey Lessel · Answer

Dion -- thanks for the response. A couple clarifications:

As I mentioned in my above post, the verbal offer contained a 3-year balloon but I am not considering the balloon in the numbers here. If that deal goes through, then I might just hold the note for 3 years. I am more interested in the concept of if a note buyer would even consider buying a note like this as if it was in 1st position if, in the sales agreement, it is stated that the proceeds of the sale of the note would go first to paying off entirely the original 1st lien.

The potential buyer that made the verbal offer is not a desperate borrower in my initial conversations with him. He is a local investor who owns multiple rentals in the area and would like to purchase the property to hold as a rental. I haven't dug deep into his borrowing history nor will I until I decide this is the route I'd like to take (which I'm still not sure of).

As for the "obvious question": "Why are you not selling the property in the open market for $73k or even $65k"? That is a very relevant question. There are a few different reasons:

1) I've attempted to sell the property straight up and while there has been some interest from buyers in purchasing the property, all of them have so far been unable to obtain a loan.

2) I imagine that offering owner financing would open the doors to many more potential buyers.

3) I'd like to get some experience with notes. I can be a little patient in terms of getting my money out of this property and I thought that this could potentially help in getting my foot in the door of the note world. I'm willing to take a larger discount for the experience and knowledge.

As for the property value, it's Zestimate is $90k+. I can hear your eyes rolling. =)

The ONLY reason I point out the Zestimate is to show how crazy this particular area is. I don't believe the property is worth $90k but I do believe it is worth every bit of $70k retail. This particular area is good or bad block-by-block. This one happens to be an excellent block. A smaller house (though rehabbed) sold for $110k+ just 6 houses north of this one. Mine does not need anything other than cosmetic updates and is larger. I believe the massive value swings block by block have also hindered my attempts at selling it straight up.

Regarding the balance of the 1st lien, I'd rather not openly discuss that until this property is sold. I can say that I'd like to receive $50k in order to pay off the loan and have some capital for another project. I am anticipating getting at least $10k more out of it after all is said and done.

Geoffrey Lessel · Answer

Thanks for the replies guys. To explain further, I would pay the first mortgage monthly payments and my buyer would pay me as a second. If (and that's a big if) I can sell the note, I would use the sale to pay off the first.

I haven't done this before but here's some quick calculations I've come up with. Let me know if I'm out of line with these numbers:

Purchase price of $73,000; $8,000 down.

$65,000 financed at 10% over 240 months. I've had one verbal offer like this with a balloon payment after 3 years (though a balloon isn't considered in these numbers).

If I can season it for a year, 228 months remain. I could sell 200 months of payments for ~$51k which would offer the note buyer a return of 13% (is that a marketable rate?). That would pay off the first and then some.

Is that doable? Is it possible to do this with a land contract so as to avoid the first's due on sale clause?

As for the usury limit in AR, it was recently (within the past 2 years) raised to 17% so I'm good there (constitutional amendment 89 if interested). It was ridiculous how low it was for years.

Turning a 2nd lien into a 1st when selling the note?

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