Structuring the Seller Second
While our nation’s leader refashions himself as a wartime president, battling the Coronavirus, many sellers will wake up to their own war and a new reality this week. The aftermath will include the realization that a substantial portion of their sales transactions are dead or will need restructuring due to hard money investors reducing the maximum they are willing to lend on purchase loans.
We anticipate a trend where lenders will retreat to playing it safe by lowering their LTV (loan amounts to appraised value or purchase price), tightening restrictions on new construction purchase loans and demanding higher borrower credit scores. Pressure will come from borrowers/buyers faced with having to come up with a higher down payment at a time when the next paycheck is uncertain and the economy is shaky creating an innate desire to hang on to their cash for a rainy day.
We predict that sellers whose buyer pipeline shrinks will be faced with a decision. To take on more risk in the deal, be more creative to help their buyers out or simply rescind the purchase contract and walk away.
Besides reducing the sales price, the seller second is an excellent option.
Last week we published an article about how the seller second mortgage works. 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.
Here is a scenario on how we see these deals structured:
Let us say, a seller wants $500K for their property. This is what she needs to make the deal profitable for her. Based on our algorithm, the appraised value needs to be at no less than $1.192M. Since the first mortgage LTV is capped at 50% when utilizing seller seconds, the loan amount to the buyer cannot exceed $596K. After title, points and other fees are removed, the Seller will walk away with $500K, the buyer will own the property with two mortgages outstanding. The 1st mortgage will have a monthly payment, but the Seller holding the second mortgage could waive payments to six months or even a year, freeing up the new owner’s cash, giving them more time to fix and keep, or sell the property and settle everyone’s interest down the road.
Appraisals are at the core of the Seller second – if value does not come in as needed, the deal falls through. As such, new construction loans tend to have the least success because the value of the property tends to be equal to the sales price with no equity to leverage. Western Capital structures these deals every day and we want to give you, our borrowers options.
If you have any comments on your own experiences or feedback on this article, I would love to hear them.