THE ADVANTAGE OF THE SECOND MORTGAGE
THE ADVANTAGE OF THE SECOND MORTGAGE
When I first started in the lending business almost 50 years ago, we did almost entirely SECOND mortgage lending. leaving the first mortgage lending business largely to banks and to "loan to own" lenders. These "loan to own" lenders were in fact often our take out lenders for our non performing borrowers. In many situations they were a guaranteed exit.
Second mortgage loans are almost always much smaller in size, thus allowing an investor or lender with limited capital more diversification. Intendant in this is the ability to just write off a small loan, walking away from a bad situation.
The major advantage of the second mortgage loan to the lender however is that these loans will stay on the books longer and earn a higher rate of interest than a first mortgage.Experience has shown that this will generate a 4% or greater improvement in IRR for a portfolio.
For many years I did foreclosures for the Money Store. One very profitable money store product was the "peanut behind the elephant", essentially a 10% or less 2nd mortgage behind a 90% first mortgage. CLTV was only a minor consideration although we had a theoretical 125% maximum. Without boring you with the arithmetic suffice it to say that we were prepared to write off 10% of these loans within the first year. The interest rates were generally 8%+- higher than the prevailing first mortgage rate.
Those existing first mortgage rates were MORE THAN TWICE todays prevailing rate.
Today 2nd mortgages can be written at 12%+- above the prevailing commercial mortgage rate.
The write off experience turned out to be half of the 10% until a major collapse in the real estate market some 10 years after the introduction of the product. During those 10 years this product was ASTRONOMICALLY PROFITABLE since the loans were highly leveraged through the use of REMICS, allowing a gross total of some $900MILLION of originations across the US and a bottom line profit of at least $100MILLION over the 10 years allowing the multimillion dollar sale of the company to a major bank.
At toys much lower carrying cost for the first mortgage todays write off rate should be almost non existent without a serious collapse in real estate values!!!
Real estate prices then collapsed, the bank failed, the underlying loans were sold for pennies and aggregated enormous unpaid interest and eventually returned by my rough reckoning an annual IRR or well over 10% based on the original book value and 40% or 50% based upon the salvage purchase investor price. Profits in the default period (LTV's being around 160%!!) for the salvage investors GREATLY EXCEEDED the Money Store business plan operating profits!!!!
The existing first mortgage is actually an asset since as a practical matter it rarely if ever has to be paid off immediately in the event of foreclosure of the second mortgage. Equally as important is that often a strong relationship will be developed with the servicer of the first mortgage, AN EXCELLENT SOURCE OF REFERRALS AND/OR CAPITAL FOR OTHER DEALS. since that servicer has delinquent first mortgagors who need to borrow to bring the first current.
Of great if not immediately obvious importance is that REAL ESTATE TENDS OVER THE VERY LONG TERM TO INCREASE IN VALUE QUITE RELIABLY. With the same amount of money SPREAD BETWEEN A LOT OF SECONDS, the mortgagee has a mortgage ON A LOT MORE PROPERTIES increasing in value several times faster than underlying first mortgages of the same aggregate amount would.
By all logic todays first mortgage low interest and carrying rates should make a similar lending program today long term bullet proof for investors with the staying power.
Note that origination LTV. is largely irrelevant assuming long term growth in real estate values.
pl goduti
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