Buying a 2nd lien note with owner in bankruptcy

[Han Oh]

I am in contact with a 2nd position private lender who is willing to sell his note at a small discount. The property is in California, the sale date is scheduled for mid December and he is the foreclosing lender. There is a 1st in place which was previously in preforeclosure but that has issued notice of rescission and I can't find any default notice since then. The current owner has filed for bankruptcy about a month ago and the 2nd position lender is saying that he is in the process of getting a release of stay from the court which should happen pretty soon. I do not yet have information on whether it is a Chapter 7 or 13 bankruptcy as I have yet to make more detailed contact with the lender. There is plenty of equity in the house.

I'm thinking about purchasing the note from the lender after bankruptcy is lifted and taking over his foreclosure process. 

Being this my first note purchase experience, what are the risks and potential complications that could arise from this? If the bankruptcy was filed just one month ago by the owner, why would the court grant the release so soon especially if there is a payment plan in place, and can the 2nd position lender request for the release? Can the court order the 2nd lien to be reduced or even relinquished due to the owner being in bankruptcy? Do I run any risk of losing part or all of my investment?

I sincerely appreciate all of your responses in advance.

Happy Thanksgiving!

[Joshua Andrews]

Hi Han,

There is nothing wrong with buying a loan in this condition. A few things you need to be clear on prior to purchasing. I am sure there are others but these immediately come to mind.

1. Find out the 1st mortgage payment amount and if it's current or in default.

2. Determine how much equity is really in the property. Be conservative and account for resale fees, legal, and other expenses. These can add up fast.

3. Find out what type of bankruptcy are they in.

4. Get the borrowers first and last name, and last four digits of their social. Go to pacer . gov and look up their BK filing. Learn everything you can about that situation and what has been filed. It is all available virtually for free at pacer.

5. I would also ask for a hefty discount in a situation like this. I realize the property has equity and is in California, which is a non judicial foreclosure state, but you should still be buying with a hefty discount, not a slight one. Regardless of the outcome you will be laying out money or waiting months before a resolution is realized. I am not saying this is a bad deal, just something to be aware of.

Since all you stand to gain is what is owed on the 2nd lien, you should be buying at much less than what it's worth. That difference between what you paid and what they owe on the 2nd lien is your profit. Your risk or exposure is having to extend legal fees and possibly carrying the 1st mortgage until you can sell the property once you have taken legal ownership through a foreclosure via the 2nd lien.

Here are my responses to your questions below in ITALICS.

QUESTION: Being this my first note purchase experience, what are the risks and potential complications that could arise from this? 

ANSWER: Many things could arise. It could still be a good deal if you have all the information up front. I would suggest getting a title report to start with.

QUESTION: If the bankruptcy was filed just one month ago by the owner, why would the court grant the release so soon especially if there is a payment plan in place, and can the 2nd position lender request for the release?

ANSWER: A payment plan for debts will only be in place on a Chapter 13 bankruptcy. A chapter 7 will have no payment plans to many creditors. I don't have all the information to comment on why the stay would be lifted quickly. You need to find more information on the filings via pacer.

QUESTION: Can the court order the 2nd lien to be reduced or even relinquished due to the owner being in bankruptcy?

ANSWER: No. 2nd liens cannot be stripped or "wiped" in California. The bankruptcy could potentially stall your being able to foreclose or recover your investment for a good deal of time though.

QUESTION: Do I run any risk of losing part or all of my investment?

ANSWER: In almost all situations, the answer is yes. If you cannot afford to lose the money I would not suggest purchasing. However, this could be a solid deal. We don't have the actual figures here in order to make an informed decision. There are a great deal of nuances here. I would suggest having someone with more experience guide you on a purchase like this and not trying to do it yourself. Or, simply start with a more vanilla note purchase with a defaulted 2nd lien.

Hope that helps.

Josh