You’re selling your real estate and you have a good offer. But your buyer doesn’t qualify for more than a new 70% to 80% loan and is short on the down payment. The usual answer is for the buyer to offer you a second mortgage note to make up the difference. What should you do?
The two risks in a small second
First, recognize the possible hazards of accepting such an offer. Watch for two problems:
- the buyer may not be able to pay your second mortgage note; and
- selling your note can be difficult or impossible at a reasonable cash price.
You could end up with a worthless or frozen asset. But there are ways to reduce the risks of accepting a second mortgage note, and reasonable steps you can take to protect yourself.
Make sure the first lien lender knows everything
Before you sign the final papers agreeing to sell your property, make sure the first lien lender knows about your second mortgage note. You want to guard against it being a “silent second” that the buyer is hiding from the lender.
If the lender would refuse to approve your second, that may indicate your buyer is over-extended. Making sure the first lien lender knows about your note is an important way to protect yourself from default by a buyer who cannot pay.
The lender must know not only that your note exists but also all of its terms. You want to avoid a situation where the lender approves your second mortgage without realizing your buyer will be making monthly payments on it. Every term of your note must be disclosed to the first lien lender, and you need to satisfy yourself that full disclosure has been made.
Learn the terms of the first mortgage
Just as the first lien lender must know about you and your note, you must know about the first lien lender and the terms of the first mortgage. Those terms tell you vital things about your own note.
For example, the interest rate on the first mortgage tells you what the lender thinks of the buyer’s creditworthiness. A higher rate might indicate a higher credit risk, and you should know about it. You also need to know about the monthly payments, problem clauses, balloon payments and other snags, because your buyer could default on the first mortgage. If that happens, you will have to pay the first lien lender to protect your interest in the second. Without full information, you can’t prepare for that.
There’s another reason to know the first mortgage terms. If you ever sell your second mortgage note, your note buyer will want all of this information to calculate its own risk.
Get written permission from your buyer
The crucial point: you need your buyer’s written permission to get information from the first lien lender. It should cover not only the loan’s terms and conditions but also the lender’s credit and financial information on your buyer.
Always get this written authorization before you sign the final papers agreeing to sell your property, and make sure it lasts for the full term of your second mortgage note.
Add security with a co-signer or collateral
Finally, you can reinforce your note by asking for additional security. One way is a co-signer. Often a parent, relative or friend of the buyer will be willing to sign for a small second mortgage note. If you do get a co-signer, get a financial and credit report on them to make sure they have the means to pay if necessary.
If a co-signer can’t be found, you can accept security on other real estate or on personal property the buyer owns, such as vehicles, boats, collections, jewelry or art. Always get a professional appraiser’s opinion of the value of this security, and get all the proper legal instruments to perfect your security interest.
Once you have taken care of these basics, you can sell your property and accept a small second mortgage note knowing you have been both prudent and resourceful. You sold your real estate and protected your assets by reasonable means.
