The Elusive 100% Seller Second Mortgage
Seller seconds are a fantastic option to gain ownership of high value property that would otherwise be out of reach for buyers with little money down.
What is a seller second mortgage?
Briefly, it is when the seller will extend a mortgage note to the buyer and help him get to 100% financing. The seller will continue to have a security interest in the property by holding a lien position on the title, second position behind the primary lending investor. This allows the borrower to acquire the property without having to come in with any more cash.
How does a seller second mortgage work?
Here is what we typically see and generally how it works; A seller wants to get rid of their $500K mixed-use commercial property and can’t seem to get an offer. A hopeful buyer approaches her with a deal that sounds good.
They agree to bump up the sales price from $500K to $1 Million. The borrower then submits a loan application at this new sales price to us, looking for an investor to lend the maximum (LTV) loan amount against a property value of $1 Million.
At the close of this transaction, the seller gets what the money they need, the borrower acquires their new property with the down payment and closing costs covered, everyone goes home happy.
Through initial screening, Western Capital LLC gets this borrower pre-approved for 80% LTV. We then ask the borrower where the 20% down payment funds will be coming from.
The lending investor will most likely want to see the borrower’s bank statement confirming the availability of these funds. The borrower then confesses that they can’t produce such a statement and that the seller is willing to help out – They will fund the down payment and closing costs to get this financing to 100% CLTV (Combined Loan to Value), so the borrower will not need to come in with any cash out of pocket.
This is where most deals begin to unravel. Any borrower trying to structure something like this should consider these four things:
1. Once the lender is aware of a seller’s “generosity” to finance a second position mortgage to satisfy 100% of the borrower’s down payment requirement, the lender will cap the maximum LTV limit to 50% of the appraised value, versus the 80% initially quoted.
2. Every lender will need an appraisal, most will want to order their own to make sure the appraiser is not biased to give the property a higher value than it is worth. Most lenders will instruct the appraiser to generate a quick sale value, banking on the probability of borrower loan default so that the investor can sell the property and get it off their portfolio quickly. In this scenario, if the appraisal comes back at a valuation of $600K, the deal falls apart. The loan amount drops to $300K, making it unprofitable for the seller who will not get the clandestine agreed upon amount of $500K. She walks away from the deal.
3. Investors are not comfortable lending 100% CLTV with borrowers not having any “skin” in the game. If things get tough after closing, the borrower tends to abandon the property. Most investors we have seen in this space will not give any rehab funds due to the high risk of the borrower not completing the project and improving the value of the property down the road.
4. The biggest gaffe we see on these applications is a prior listing. Public forums such as Zillow, LoopNet, or Realtor.com, will pick up any aged or cancelled listings where the seller had initially tried to sell the property for… drum roll… you guessed it, $500K! They will show, for example, that the listing sat on the market for 6 months or even a year! They will figure that the seller could not get rid of this property to save their lives. Then lo behold! What do you know – they have found a buyer now, willing to pay twice the price it was originally listed at! Believe me, underwriters Google the subject property address too.
Seller seconds are great for all parties involved, if they make sense to the investor who will be financing the deal and if the property appraises well. Lenders are wise to it, unfortunately. If they have the slightest hint of what is going down, they quickly set their underwriting requirements to be sure their loan position is secure if the deal hits the fan.
Next week we will post a follow up article on how to structure these elusive 100% Seller Seconds and get them approved.
If you have any comments on your own experiences or feedback on this article, I would love to hear them.