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August 2012 - The risk of investing in 2nd or 3rd mortgage.

The risk of investing in 2nd or 3rd mortgage.

☳ by Adam Aspilla

It is a common understanding that when you invest your money in mortgages where it is secured by real estate, said investment is really safe.  Really? Not at all! 

Security in investing real estate mortgages depends on what kind of mortgage: 1st, 2nd, or 3rd mortgages and the equity of the property use as collateral.

First mortgage, is safer than the 2nd or 3rd mortgage for in the event of default on the part of the mortgagor (borrower), and the property is sold through power of sale, the 1st mortgage will be paid first before paying the 2nd, then 3rd mortgage in that order.

For example: If a property is sold under power of sale and had three mortgages. The 1st mortgage: $150,000.00; 2ndmortgage: $70,000.00; and 3rdmortgage: $30,000.00. Adding those three mortgages, the total amount is $250,000.00.

Assuming the said property was sold for only $225,000.00 for house prices went down because of bad economy, and after paying agent commission, legal fees, taxes, and other related disbursements the net proceeds was only $200,000.00.

The $200,000.00 will be disbursed as follows: $150,000.00 will be paid to the 1st mortgage; $50,000.00 to the 2nd mortgage. Nothing will be paid to the 3rd mortgage for there was no more money left.

You will notice the amount paid for the second mortgage was only $50,000.00 for that was the only amount left after the first mortgage was paid in full. Meaning, the 2nd mortgage investor lost $20,000.00 of his $70,000.00 capital invested. While the third mortgage investor lost 100% of his $30,000.00 capital invested.

The above scenario is very realistic considering the volatility of the real estate market because of economic uncertainty in our global economy. In fact in the United States of America thousands of houses were foreclosed because homeowners abandoned them for the value of their houses are much lower than the amount of their mortgages.

It is attractive to invest in 2nd and 3rd mortgages for you will earn high interest from 12% and up per annum plus lender’s bonus on top of the interest.

If you planned to invest in 2nd or 3rd mortgages, don’t be obsessed of earning high interest and lender’s bonus, you have to be cautious, otherwise, you will kiss goodbye to your money invested.

First, you have to consider the equity of the house. Meaning, you have to be conservative, avoid lending more that 85% of the appraised value of the house. 

Second, do not invest all your money in one property (diversify on different residential properties) for if that property went to power of sale you assume the risk of losing part or all of your capital investment as in the above case scenario, and you have nothing more to invest.

Third, if you are a small investor you may avoid investing on commercial or industrial properties for these properties take time to sell in case of default on the part of the borrower.

Because of the risk of investing in 2nd or 3rd mortgages, you may decide to invest a maximum of $20,000.00, $25,000.00 or $30,000.00 for each mortgage investment depending on your comfort level. 

By the way the writer will conduct a two-part seminar on Financial Management on September 15 & 22, where he discusses topics on finances including “How to Own a House Mortgage-Payment Free” For details see Ad on page 34 in this paper.

 

 

Adam Aspilla is a Senior Financial Counselor of the Debt Clinic of Canada Inc. and the author of the book, You Can Negotiate All Your Debts. He also writes a biweekly column, “What Matters In Life” in “Taliba Newspaper. For free initial, professional and confidential consultation, please call 905-306-7572.