Using Two Mortgages I

n the Case Studies above, we got around the 20 percent down payment financing requirement by using a seller-carryback loan (discussed in more detail in Article 9). This type of loan is known as an 80-15-5 loan; you borrow a first mortgage loan for 80 percent of the purchase price, ask the seller to accept a note for 15 percent of the purchase price, and put down the balance of 5 percent in cash. There are many variations to this formula, such as 80-10-10 (80 percent first mortgage, 10 percent second mortgage, 10 percent down). In Case Study #2, the seller accepted a note and second mortgage for part of the purchase price. The 10 percent (or more) can also be borrowed from a third party, such as an institutional lender. The ad vantage of using two loans as opposed to one 90 percent or 95 percent LTV loan, is that the underwriting requirements are easier on the 80 percent LTV first mortgage loan (and you avoid the PMI requirement, discussed in Article 3). Generally speaking, nonconforming lenders aren’t as concerned with the source of the down payment or whether the borrower offers cash or a note (or other financing) for the balance of the purchase price. So long as the primary lender is in a first mortgage lien position at 80 percent LTV or less, they are fine with the seller accepting a note or the borrower obtaining some of the difference in the form of a second mortgage loan.

No Documentation and Nonincome Verification Loans

Conforming loans generally require strict proof of income, assets, and other debts. If, for example, you cannot prove income to a lender, whether it is because you are self-employed for a short time or can’t otherwise prove income, there are nonincome verification (NIV) loans. NIV loans (also known as “stated income” loans) require less documentation than traditional loans. Lenders often advertise these programs as “no doc” loans, meaning the borrower does not have to come up with any documentation other than a credit report and a loan application.

How to Calculate a Blended Interest Rate

Multiply each interest rate times the amount it relates to the total debt, then add them together. For example, if you have an $80,000 first mortgage loan at 8%, and a $20,000 second mortgage loan at 10%, the blended rate is (8% × .8) + (10% × .2) = 8.4%.

Some loans are called “no ratio” loans, in that you don’t have to justify your total debt (mortgages plus other continuing obligations, such as car loans and student loans) compared to your income. Few, if any loans are true “no documentation” loans. Most of these offered programs are bait and switch tactics: The lender says they don’t need documentation, but when the loan is being processed, the lender will ask for more and more documentation.

Often, the lender will see some red f lags that trigger the additional inquiry. The best defense to these tactics is a good offense; speak to your lender or mortgage broker up front. Identify documentation issues up front, educate the lender about your finances, and be truthful. The more a lender suspects you are hiding something, the more documentation the lender will ask for. Here is a real-world example: Carteret Mortgage, <www.nvamortgage. com>, lists the following general guidelines for one of its no-ratio mortgage loans:

• Minimum middle credit score must be 640.

• Five credit accounts are required; three may be from alternative sources—utility, auto insurance, etc.

• Bankruptcy and foreclosures must be discharged for three years with reestablished credit.

• Two years’ employment with same employer.

• Two months’ PITI reserves are required with an LTV less than 80 percent. Six months’ reserves are required otherwise.

• 10 percent minimum down payment is required from your own funds. No gifts. You should ask for this kind of information up front from your mortgage broker or lender. The more information you know about what a lender needs, the more information you can provide.

Develop a Loan Package

You should present a loan package of your own to any new lender. This package should include the following:

• Your completed FNMA Form 1003 loan application.

• A recent copy of your credit report, with written explanations of negative information

• A copy of the purchase contract for the subject property

• A copy of the down payment check and documented proof of where it came from

• Copies of recent tax returns, pay stubs, and W-2s (if applicable)

• Recent appraisal of the property if you have one, or a market analysis prepared by a real estate agent

• Copies of existing leases or information of rental value of similar Properties

• Copies of recent bank statements, retirement plan accounts, and brokerage accounts

• Any other relevant financial information concerning assets or liabilities.

• References from other bankers, lenders, or prominent members of your community, such as a judge, politician, or bank president The more information you provide up front, the less surprises the lender runs into, and hence the less likely it will be suspicious and ask for more documentation.

Subordination and Substitution of Collateral

Subordination is asking someone who holds a mortgage (or deed of trust) on your property to agree to make his or her lien subordinate, or second in line, to another lien. For example, suppose you own a property worth $100,000 that has a first mortgage to ABC Savings Bank for $65,000. If you want to borrow $30,000 from First National Bank secured by a second mortgage, you would have to pay a much higher interest rate because First National’s mortgage would be subordinate, or second, to the lien in favor of ABC Savings Bank. A second lien position is riskier than a first lien position, so the interest rate is generally higher to compensate the lender for its increased risk.

If you could convince ABC Savings Bank to move its lien to second position, First National would now be a first mortgage holder and thus give you a better interest rate. Keep in mind that you can use subordination to draw cash on properties you already own. If you* purchased a property with seller financing, simply ask the former owner to subordinate his or her mortgage to a new first. This may require you to give the seller some incentive, such as additional cash or paydown of the principal. Either way, subordination is an excellent way to finance a purchase or draw money out of existing properties. Substitution of collateral is a method of moving a lien from one property, or collateral, to another. The substituted property does not necessarily have to be real estate. You can use a car or boat title as the substitute collateral. Better yet, get the mortgage holder to release the mortgage with no substitute collateral! To get someone to take a note without collateral, you need to offer a substantial cash down payment. Think about this: If the note you give the seller is not secured by the property, you can refinance or sell the real estate without paying off the note.

Case Study: Subordination and Substitution

A property owner (we’ll call her Mrs. Seller) called me to discuss selling her house. After some negotiations, we agreed to purchase the property for $63,000 as follows:

• $35,000 cash at closing of title

• Promissory note and second mortgage (subordinate to a new first) for $28,000, payable in installments of $350 per month, no interest. She owned the house free and clear, so why would she do such a thing? The answer is, to have her needs met. After some discussion, she told me that she was sick of the upkeep of the property and wanted a brand-new doublewide mobile home. The $35,000 cash was for the new home, and the $350 per month would pay her mobile home lot rent (just so you know that I didn’t “steal” the property from some little old lady!). I went to a hard-money lender (discussed in Article 6) and borrowed $37,500 at 12 percent interest (only $35,000 went to the seller; the extra cash was for the points on the loan). I closed escrow, placing a new first mortgage in favor of the hard-money lender, and a second mortgage (subordinate to the first) in favor of the seller for $28,000. My total monthly payments were $725 per month, and I rented the property to a nice family for $800 per month. A few years later, I wanted to sell the property, so I called Mrs. Seller and asked if she would be willing to take a discount on the amount we still owed her, which was approximately $20,000 (remember the original amount was $28,000). She said that she liked the monthly payments and didn’t want me to pay her off! With that, she agreed to accept $10,000, release the mortgage from the property, and allow us to continue making payments on the $10,000 balance of the unsecured promissory note. Not only did we profit from the sale of the property, we also walked away from closing with an extra $10,000 cash in our pockets! The extra cash was due to the fact that we only paid her $10,000 towards the balance of the $20,000 debt still remaining. We continued to make monthly payments on the note, but because the security (mortgage) was released from the property, we received the cash from the proceeds of the sale. As you can see, subordination and substitution of collateral are two powerful tools to make you more money in real estate.

Using Additional Collateral

If the lender you are dealing with feels uncomfortable with the collateral or your LTV requirements, offer additional security for the loan. There are several ways to securitize a loan, other than with a lien on the subject property.

Blanket Mortgage

A blanket mortgage is a lien that covers multiple properties. Developers often use a blanket mortgage that covers several lots. When each lot is developed and sold, the lien is released from that lot. A blanket mortgage (or deed of trust) is just like a regular lien, except that it names several properties as collateral. When recorded in county records, the lien is now placed on each property named in the security instrument. If you have other property with equity, even raw land, you can offer this property as additional security for the loan. Be cautious, however, with offering your personal residence as security; failure to make payments can make you homeless!

Using Bonds as Additional Collateral

A bond, like a note, is a debt instrument. In return for the loan, the investor is paid in full at a future date. Bonds generally pay interest at fixed periods, unless they are zero-coupon bonds. The cash value of a bond at any given time is based on the maturity date and its present value, which in turn is based on whether investors are speculating interest rates will rise or fall in the future. As interest rates fall, bond prices rise, and vice-versa. And, logically, the later the maturity date, the less the present value of the bond. Municipal and government bonds are virtually the same as cash; they can be traded, sold, and hypothecated (used as collateral). U.S. Treasury bonds are safe, secure investments from a risk standpoint. From an investment standpoint, they are a fair to good bet, depending on interest rates and market inf lation. Most laypeople think of bonds as being a secure investment.

Of course, institutional lenders are generally too savvy to accept the face value of a bond as collateral. However, when dealing with a private motivated seller, an owner-carry offer that is cross-collateralized with U.S. Treasury bonds sounds appealing. When making an offer to a seller with owner financing, offer the face value of the bond as collateral. Although the present value may be less, the very idea of a bond as additional collateral sounds safe. Furthermore, bonds can be used in lieu of a down payment.

Example: Sonny Seller owns a house free and clear and is asking $100,000 for his house. Brian Buyer offers Sonny $110,000 as follows: $30,000 in U.S. Treasury bonds and an $80,000 note secured by a mortgage on the property. The $30,000 in bonds, if they matured in 30 years, can be bought for a fraction of their face value, depending on the market interest rates. In the seller’s mind, he’s receiving more than the asking price, but the buyer is paying much less than the asking price (sometimes sellers are stuck on asking price just because they are ashamed to tell their neighbors they took less!). For an excellent reference on using bonds as collateral for real estate financing, I recommend Formulas for Wealth by Richard Powelson, Ph.D. (Skyward Publishing, 2001). For more information on bonds, try <www.savingsbonds.gov>.

Key Points

• Avoid loan costs on f lips—use the double closing.

• Use the middleman technique to overcome lender down payment requirements.

• Don’t let lack of income hold you back—use NIV loans.

• Think beyond the property for collateral: substitute, subordinate, and cross-collateralize.