Do You Offer Hard Money Second Mortgages in California?

The most popular question I’ve received over the past two weeks has been, “Do you offer hard money second mortgages?”

The short answer is “Yes, no, maybe, maybe not.”

In other words – it really depends on the property, use, protective equity, and much, much more.

For those not familiar with the hard money second mortgage market in California, it dried up in 2008 with the bursting of the first housing bubble. Many of the trust deed investors making second mortgages up to 70% combined Loan-To-Value (CLTV) against the inflated home values of the bubble years lost their entire principal when the homes later foreclosed.

Ever since then, very few brave souls in the trust deed investor community have wanted to test the choppy waters of private second trust deeds. The few that will make these loans, however, are very conservative and very expensive.

Let’s take a look at the “Yes, No, Maybe, and Maybe Not” answers, which hopefully will give you a better idea of what works when it comes to obtaining a second mortgage.

“Yes, we can do a hard money second mortgage”

Let’s use a common scenario where a self-employed homeowner needs to borrow money against their primary residence with loan proceeds going to pay for business expenses. As long as we can document with an invoice or work order and the cash-out funds go directly into the business bank account, the homeowner can get a business purpose second trust deed against their primary residence.

This would be a workable scenario:

  • $2,000,000 Appraised Value
  • $600,000   First Mortgage (30% LTV)
  • $500,000   New Second Mortgage for business purposes (55% CLTV)
    4-5 Points with a 9.75%% Note Rate — $4,062/mo payments
    36-60 Month Term
    12 Month Prepayment Penalty

The reasons why this scenario makes sense are:

  1. The first mortgage has a low LTV (30%) – plenty of protective equity.
  2. If the borrower were to default, it would make sense for the second to pay off the first since they are similar loan amounts.
  3. We’re documenting where the cash-out funds are going (to the business bank account for the business purposes rather than into the personal bank account for personal expenditures).

“No, we cannot do a hard money second mortgage”

Saying “No” is the most common answer we give after discussing possible hard money second mortgage scenarios with borrowers.   The vast majority of these requests come from borrowers who ran out of money remodeling their home and are looking for money to finish the project.

We had this scenario come in the other day from a Mountain View, California homeowner who called needing an extra $250,000 to finish remodeling his house (ran out of money remodeling).

Here are the loan parameters:

  • $2,300,000 Appraised Value
  • $1,450,000 – 1st Mtg – $5,919/mo (63% LTV)
  • $250,000 Needed to finish the remodel (74% LTV) ($2,708/mo)

There are several reasons this won’t work for a private money second mortgage:

  1. Combined Loan-To-Value (CLTV) of 74% is too high (greater than 65% CLTV)
  2. It’s an owner-occupied consumer loan, which is always tougher than non-owner occupied loans.
  3. There’s a huge first mortgage with a $5,708/mo payment in the first position. It defies logic to spend $1.45 million to “save” the principal on the second of $250,000 – that’s why second mortgages rarely initiate foreclosure.
  4. It’s a 7:1 ratio between the first mortgage:second mortgage.  2nd mtg lenders like being at 3:1 or 4:1.
  5. The borrower ran out of cash.  How will he service the debt on the new second mortgage if he’s already low on cash?
  6. No realistic exit strategy (besides selling the home) since regional banks and credit unions rarely offer equity lines or second mortgages to pay off our second trust deed that will be due in full (balloon payment) in 12-36 months.   The homeowner said they weren’t interested in selling the house.
  7. This is more of a friends and family loan. Or, a loan from someone in their personal network. Institutionally, this scenario doesn’t work for hard money lenders.

“Maybe we can do a hard money second mortgage.” (And “maybe not”):

A possible “maybe” and “maybe not” answer came in earlier this week on an inquiry about a commercial building in Los Angeles in escrow for $2.67 million.  The owner had three trust deeds on the property all to the same Midwest-based investment fund.  The borrower was short on cash and needed about $125,000 to make repairs to the building that the new buyer’s lender required before funding the purchase money loan.

The problem the borrower (seller) had was having three trust deeds already against the property with a CLTV up to 58% totaling $1,558,000. Very few trust deed investors would want to go in fourth position, even if it’s only for 45-60 days. Real estate transactions can go south pretty easily turning an optimistic 45-60 day assumption into a very stressful 365+ days for borrower and lender.

Here’s the “maybe” terms* the trust deed investor offered:

  • $763,000 First Trust Deed
  • $959,000 New Second Trust Deed at 12.99% for 12 months at a cost of 7 points.

*I say “maybe” because it’s a BIG maybe that the borrower would want to accept the terms since they are so expensive. Maybe the borrower could borrow the $100,000 from a friend or family member? Or maybe the trust deed investor will withdraw the offer during the week the borrower is out looking for less expensive funds. Trust deed investors tend to get cold feet the longer they have to think about a particular deal.

This one is just as much a “maybe” as it is a “maybe not” hard money second trust deed scenario. Neither party is too thrilled about the deal and would rather find something safer (for the lender) and lower priced (for the borrower).

Obtaining a hard money second trust deed in California is both difficult and expensive. Lenders will make the borrower jump through hoops to obtain a second mortgage, protecting themselves from potential default, litigation, and increased regulation.

Our recommendation to borrowers is to pursue other financing avenues, including bank financing, a cash-out first trust deed, or checking with people in your personal and professional network to gauge interest. If that doesn’t work, First Capital Trust Deeds can work with you to find a solution to your financing needs.