If you buy a first mortgage and the property has enough equity in it even after accounting for the second mortgage, another investor can swoop in, buy the second, pay you off, and walk away with the property. You don't lose the money you paid for the first mortgage, but you do lose the property and the opportunity to earn a bigger profit. When you buy a first mortgage on a property that has sufficient equity to tempt another investor to buy the second, you can employ any of the following strategies to protect your investment:
i Pay off the second mortgage. If the second mortgage is low enough, you may want to simply pay it off. I'm not saying you should always pay off the second mortgage, but if you crunch the numbers and can still earn a tidy profit, this is an option.
i Buy the second mortgage at a discount. You may be able to buy the second mortgage at a discount from the lien holder or, if the lien holder forecloses on the property, you may be able to buy it at auction to protect your position. If the lien holder is unwilling to sell short, let him know that you own the senior position and that if the homeowners don't redeem, he stands to lose everything.
i Convince the owner of the second mortgage not to sell to another investor. Contact the second lien holder and let her know that you purchased the first and that if nobody redeems your mortgage and the second lien holder agrees not to sell or assign its position, you will pay her some fixed amount (as determined in your budget). If she agrees, have your attorney draw up an agreement. This prevents another investor from buying the second and then redeeming the first mortgage. This strategy offers two benefits: You don't have to come up with the money upfront to buy the second mortgage, and the second lien holder doesn't have to give up her position — if the homeowners redeem your first, the second lien holder retains its position and can now foreclose for full value rather than selling short to you.
i Overbid enough at the sale to satisfy the second mortgage. You can essentially pay off the second mortgage by bidding enough to satisfy that debt or provide enough money to the second lien holder, so redeeming you or selling their position to another investor would not be worth the time and hassle.
Was this article helpful?