The Upsides & Downsides of Doing a 2nd Deed of Trust

Dear Valued Investor,

As a private lender, staying informed about the nuances of various investment options is crucial.  In this article I wanted to explore the intricacies of funding a second mortgage — an investment opportunity that can offer significant rewards but also carries certain risks. Understanding these factors can help you make informed decisions and optimize your lending strategy.

Given the higher conventional/bank rates (6.5-8.5% average rate recently) there are many Borrowers looking for a second mortgage as they do not wish to pay off their 2% – 4% low rate first mortgage.  However, this opens the door to new investment potential but understanding the risks and rewards is important!

The Upsides of a 2nd Mortgage Private Trust Deed

1. Higher Potential Returns
   Second mortgages often provide higher interest rates compared to first mortgages due to the increased risk involved.  As a result, private lenders can enjoy more substantial returns on their investments.
2. Diversification
   Investing in second mortgages allows you to diversify, spreading risk across different types of assets and reducing exposure to any single investment class.
3. Secured Investment
   Although second mortgages are subordinate to first mortgages, they are still secured by real property.  This means you have a claim on the property in the event of default, which can help mitigate losses. 
4. Flexibility in Terms
   Private trust deeds can be tailored to suit the needs of both the lender and borrower. This flexibility allows you to negotiate terms that align with your investment goals and risk tolerance.
5. Potential for Refinance Opportunities
   If the borrower refinances their first mortgage, this would move the second mortgage into first position, potentially improving your investment position.

The Downsides of a 2nd Mortgage Private Trust Deed

1. Increased Risk
   Second mortgages are subordinate to first mortgages, meaning that in the event of a foreclosure, the first mortgage lender will be paid before any funds are distributed to second mortgage holders. This increases the risk of potential losses.
2. Additional Reserves Need to be Held by Lender
   In situations where the first mortgage holder files a Notice of Default, the second mortgage holder might need to come in with funds to bring that mortgage current.  Thereby allowing the second mortgage holder to proceed with their Notice of Default and Foreclosure.  While these fees can be added to the Borrower’s payoff demand, it is a reserve the Lender would want to keep available.
3. Higher Loan-To-Value Risks
   Typically, the LTV for a second mortgage is calculated based on the combined loan amounts (first and second mortgages) relative to the home’s appraised/assessed value. A high combined LTV ratio indicates higher risk for lenders.
4. Interest Rate Sensitivity
   Changes in interest rates can impact the value and attractiveness of second mortgages.  Rising rates may affect the borrower’s ability to make payments if their first mortgage is an adjustable-rate mortgage, increasing the risk of default.

Mitigating Risks

To maximize the benefits and minimize the downsides of investing in second mortgage private trust deeds, consider the following strategies:

1. Due Diligence: Perform your due diligence on the property and borrower to assess these against your own risk tolerance.  This would include a review of the first mortgage holder’s Note to see the terms and conditions of that mortgage.
2. Clear Loan Terms: Ensure that the terms of the loan are clearly defined and agreed to by borrower and lender.
3. Well Drafted Loan Documents: Having well-drafted loan documents ensures you have clear legal protection, avoidance of disputes, and regulatory compliance in place.
4. Risk Management: Diversify your investments and use risk management strategies to protect your portfolio.

I hope this overview helps you better understand the opportunities and challenges associated with second mortgage private trust deeds.  As always, feel free to reach out if you have any questions or would like to invest!

Warm regards,
Ken Walker
Broker/Owner
Pacific Direct Mortgage & Real Estate, Inc

DRE #01858042 / NMLS #1221130
Phone: 707-708-0797 
Office:  1400 N Dutton Ave #22 Santa Rosa, CA 95401