The key to making money when buying discounted cash flows is to be able to find the best notes at the best discounts with minimal to no risk. In other words, the key is to "sift the wheat from the chaff." This advice is especially important when buying a second.
Many of us have purchased and profited from buying second mortgages. However, as with any investment, you want to avoid any pitfalls. You should be on the look out for what FNMA calls "Silent Seconds."
These are notes created from the sale of real estate with a seemingly good down payment, a new first loan and the second trust deed or mortgage note. However, the first lender is unaware of the second note, which is where the name "Silent Second" comes in. These notes are usually kept silent because the buyer cannot qualify for a large enough first loan.
Many of us have purchased and profited from buying second mortgages. However, as with any investment, you want to avoid any pitfalls. You should be on the look out for what FNMA calls "Silent Seconds."
These are notes created from the sale of real estate with a seemingly good down payment, a new first loan and the second trust deed or mortgage note. However, the first lender is unaware of the second note, which is where the name "Silent Second" comes in. These notes are usually kept silent because the buyer cannot qualify for a large enough first loan.
An example...
Let's take a look at a real-life example. The buyer purchases a single family home for $135,000. The first lender agrees to make a loan of 80% or $108,000. Therefore, the buyer has to come up with $27,000, right? Normally this would be correct, but not in this case!
The buyer and the seller make a side agreement to create a note outside of escrow and without the knowledge of the first lender. They claim the buyer has put down $27,000, but in reality he only puts down $15,000. The buyer gets the first loan for $108,000 and gives the seller a "Silent Second" for $12,000 which is the remaining balance.
The first lender is unaware of both the smaller down payment and the second note for $12,000. If the lender knew about these factors, it would have never approved the loan. Is this practice illegal? You bet it is! Do you want to buy these type of notes? NO!
The buyer and the seller make a side agreement to create a note outside of escrow and without the knowledge of the first lender. They claim the buyer has put down $27,000, but in reality he only puts down $15,000. The buyer gets the first loan for $108,000 and gives the seller a "Silent Second" for $12,000 which is the remaining balance.
The first lender is unaware of both the smaller down payment and the second note for $12,000. If the lender knew about these factors, it would have never approved the loan. Is this practice illegal? You bet it is! Do you want to buy these type of notes? NO!
Always examine the closing statement
So how can you tell if you have a "Silent Second"? One way to tell is to look at the closing statement which should include when the note was created. If the second you hold or are thinking about purchasing is not shown on the closing statement, then it's probably a "Silent Second."
But, here's another problem...What if the closing statement you have received from the note seller has been forged? What if the note seller has added in the second note to the original closing statement?
Always cross check your documents with the documents from the title or escrow company before closing the transaction. This way you will be able to check whether the figures and signatures are correct.
But, here's another problem...What if the closing statement you have received from the note seller has been forged? What if the note seller has added in the second note to the original closing statement?
Always cross check your documents with the documents from the title or escrow company before closing the transaction. This way you will be able to check whether the figures and signatures are correct.
A widespread problem
Many buyers and sellers of real estate enter into these types of "side" transactions without realizing that this practice is illegal. If deliberate fraud is involved (and what kind of fraud isn't deliberate?) then the penalties are severe. This is a very widespread problem. If you are careful, you can avoid this pitfall.
So, in short, always do your homework when buying any note! If it's a second trust deed or mortgage note, do a little more work! When you call or write to the senior lender to check the loan balance, also ask him if he is aware of a second note that exists.
So, in short, always do your homework when buying any note! If it's a second trust deed or mortgage note, do a little more work! When you call or write to the senior lender to check the loan balance, also ask him if he is aware of a second note that exists.
