Reduce Risk when Holding a 2nd Mortgage

A 2nd Mortgage Can Attract More Buyers
There are times when a home seller will entertain holding a second mortgage as an incentive to attract more buyers.

However, here is an important but often overlooked aspect of deciding to hold a 2nd mortgage. The 1st mortgage lender will want to insure that the payments for both the 1st and 2nd mortgage fall within the buyer’s ability to pay. If not, the 1st mortgage lender will not approve.

Can a 2nd Mortgage Achieve a Higher Price?
The seller may use the 2nd mortgage as a way to obtain more money for the home. Again, let’s say that the 1st mortgagee lender says okay to the seller 2nd mortgage. The approval would still be subject to an appraisal confirming whether the purchase price is justified in today’s market.

Here is an example.

The home seller voices interest in holding a 2nd mortgage that attracts a buyer. They agree to a price of $130,000, with the proposed financing of the purchase as follows:

Down Payment:                

   $10,000

Plus 2nd mortgage by Seller:    

+ $20,000

Plus 1st mortgage by Lender:  

+ $100,000

Total:                                              

= $130,000

On reviewing the agreement and the buyer, the mortgage lender disapproves lending the 1st mortgage. They determine that the buyer, based on his income, qualifies for a total mortgage amount of $100,000. Any additional amount of mortgage debt would take the buyer beyond the monthly payments he qualifies for. This would place the buyer’s ownership of the home and, therefore, the mortgages at risk. As a result, the deal dies quickly.

Gone are the hot market days when some lenders only looked at whether the buyer qualified for payment of their mortgage only.  

Other Due Diligence Considerations

Any offer of a 2nd mortgage by the Seller should be conditional on a credit check. Some Secondary Lenders don’t care about a buyer’s credit or whether a buyer has declared bankruptcy.

What is the Seller’s exit strategy? A seller often will hold a 2nd mortgage for one year on the premise that the buyer will refinance and pay out the 2nd. Yet a home owner can only refinance up to 85%. Unless the home appreciates substantially, refinancing and paying out the second may not be practical in one year. It might be better to consider a longer mortgage term of 3 years.

The buyer may decide to sell the home during the term of the mortgage. In order to insure that the seller’s mortgage is paid out on sale, the mortgage should contain a clause stating that the mortgage is not assumable.

Any thought of holding a second mortgage should be reviewed with your lawyer.

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Eugene Pilato

Eugene Pilato

Broker of Record
CENTURY 21 Today Realty Ltd., Brokerage*
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