Five Common Problems with Hard Money Second Mortgages

When you're in the world of real estate financing, navigating all the options can be a maze. Among the many choices, hard money second mortgages have emerged as a potential solution for certain borrowers. However, like all financial tools, they come with a set of challenges in addition to their benefits. In this article, we'll delve into five common problems with hard money second mortgages that borrowers should know before treading down this path.

1. Pricing Is Much Higher Than Bank or Credit Union Financing

   One of the immediate challenges with hard money second mortgages is the cost. Unlike traditional financing through banks or credit unions, these loans come at a premium. Borrowers often face closing costs ranging from 3-5 points upfront, combined with soaring interest rates that can lie anywhere between 11.00% to 13.00%. This pricing model makes it an expensive choice, especially compared to conventional lending sources.

2. First Mortgage Lender May Not Allow a Junior Lien

   Adding to the complications is the possibility that your first mortgage lender might not even permit a second mortgage to be placed on the property. This frequently pops up with high-leverage loans aimed at fixing and flipping properties, combined with rehab financing. Such loans usually have a stipulation that prohibits junior liens.

3. The Requested Combined Loan-To-Value (CLTV) is Too High

   Borrowers frequently overestimate the CLTV they can request. Many hope to get a second mortgage with a CLTV ranging from 75-90%, and some even ask for a whopping 100%. This essentially means they expect the lender to provide all the capital required to buy a new property. Unfortunately, this level of optimism is unrealistic, and can lead to disappointment.

4. Funds used for Consumer Purposes

   Most hard money lenders operate in the business purpose space, meaning they're primarily interested in financing business ventures or investments. So, when a borrower approaches them with a consumer purpose request, such as consolidating debts, renovating their house, or any other personal or household expenses, they're in for a rude awakening. Finding a hard money loan for consumer purposes is a Herculean task. In such scenarios, it's always wiser to explore alternative avenues, such as banks, credit unions, peer-to-peer lenders — or even seeking assistance from close friends and family.

5. Borrower Has an Unrealistic Second Mortgage Request

   To illustrate the gravity of some requests, one common scenario comes to mind. It's not unusual for borrowers to seek a hard money second mortgage to cover down payments and closing costs, effectively asking for 100% financing. As frequently as this request pops up, it remains an unrealistic expectation. Hard money lenders are cautious and look for assurance that the borrower has some stake in the property, commonly referred to as "skin in the game." Simply put, a deal — no matter how lucrative it might seem to the borrower — won't entice a hard money lender if the borrower isn't willing to put some money down.

Conclusion

Navigating the real estate financing landscape is complex, and while hard money second mortgages can be a solution for some, they're not devoid of challenges. With awareness of these common problems, borrowers can set realistic expectations and make more informed decisions. Always remember to thoroughly research and consult with experts before committing to any financial instrument.