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Wealth Strategy: Buying 2nd Mortgages I

Written by FrugalTrader on Oct 30, 2007 filed under Real Estate

I was going through some old stuff and found an old finance book that was written in 1990 called Wealth Building without Risk For Canadians. Within this book had a whole chapter on investing in second mortgages. I'm not sure how common these second mortgages are these days but as I am interested in real estate investing, this strategy really caught my eye.

There are times when a home vendor is willing to be the lender and do a vendor take back mortgage (VTB) in a 2nd position to the first mortgage in order to sell the home. A lawyer would draft the terms and conditions which can have multiple variations. For the purposes of this article, we'll assume that the VTB mortgage is in the second position behind the first mortgage and the payments due are interest only (like a bond).

The key behind this strategy is the idea that some VTB vendors would be willing to SELL you their mortgage at cash discount. Why would they do this? Some people would rather have, or need, the cash now and they're willing to sell it at a discount to achieve this.

The author of the book suggests to start the offer @ 60% but pay no more than 75% of the value of the mortgage. Another rule that the author follows is that he will only purchase a mortgage if the sum of all mortgages on the property is less than 80% (ie. < 80% LTV).

You're probably thinking "who in their right mind would sell their investment for 60 cents on the dollar?". Well, apparently a lot of people as the author claims that he's been purchasing these types of mortgages for years.

How do you find these mortgages:

The local registry office should have public information regarding mortgages on every property in the city.
Local real estate professionals: mortgage brokers, real estate agents, lawyers.
By advertising in the paper "We Buy Second Mortgages" or something similar.

Here is the jist of the strategy:

Investor advertises "We Buy Second Mortgages" in the local newspaper
Investor receives calls and finds someone who is interested in selling their VTB mortgage.
Investor makes an offer of 60-75% of the value of the mortgage.
Offer is accepted and investors starts to collect payments.

Tomorrow, i'll continue with part 2 of buying second mortgages which includes an example along with the pros/cons that I can see from this strategy.

If anyone has any experience with this type of investing, I'd like to hear from you.

25 Comments, Comment or Ping

1. FourPillars

Is this legal?

Mike

Oct 30th, 2007 @ 8:35 am
2. FrugalTrader

FP, what do you mean? What makes it sound like it’s not legal?

Oct 30th, 2007 @ 8:53 am
3. FourPillars

Well it kind of sounds like he’s taking advantage of people - why would they sell the mortgage at 60% of the dollar unless they are desperate?

Oct 30th, 2007 @ 9:28 am
4. FrugalTrader

FP, yes, you are probably right. This strategy involves trading cash now for a discount from their mortgage price. It’s similar to buying homes at a discount, sometimes the vendors profit can be sacrificed for a fast sale. It’s all in what the vendor “needs” at the moment. Of course if it was someone more investment savvy holding the mortgage, then we would laugh at the offer. But not everyone is investment savvy and good with money.

Oct 30th, 2007 @ 9:37 am
5. Canadian Capitalist

How do you know that the vendor is selling a mortgage for liquidity? Maybe they are selling to get out and get what they can. Certainly not something I would call “without risk”.

Oct 30th, 2007 @ 12:12 pm
6. Chris

The most important rule is:
Another rule that the author follows is that he will only purchase a mortgage if the sum of all mortgages on the property is less than 80% (ie.

Oct 30th, 2007 @ 12:28 pm
7. FrugalTrader

I agree CC, due diligence is required.

Chris, I also agree with this. The 80% LTV requirement is the investors “margin of safety” as Graham would put it.

Oct 30th, 2007 @ 1:47 pm
8. FinancialJungle.com

This reminds me of sub primes in the states. The type of homeowners borrowing VTB mortgages are likely to have spotty credit histories. The risk is further compounded by being second in line in case of foreclosures.

Oct 30th, 2007 @ 1:55 pm
9. nobleea

I think the time has passed for these types of opportunities (if they can be called that). Most new mortgages today would not meet the 80% LTV requirement. With the ease of getting mortgages and credit, I think you’d have a tough time finding someone who had 20% down payment, but could not get a primary mortgage for the rest.

Oct 30th, 2007 @ 2:17 pm
10. Q Cash

I have two second mortgages which I hold in my RRSP. The first one is a VTB I did when I sold my town house in 1999. Only $10,000, but it is at 10% and the guy pays every month automatically into my RRSP. If he was smart, he would refinance and pay me off as the townhouse is now worth about $60K more.

The other second mortgage I have is one I hold on a business partners’ home. He asked me to invest in his business and I said I wasn’t interested in doing a straight investment, but I would finance a second on his home $25,000 @ 6.5% over 25 years. That mortgage is completely open and he can pay it back at any time. Could I do better than 6.5%? Probably, but it is tax free (in my RRSP). It arrives biweekly, and I immediately invest the payment into what ever investment I am looking at and it begins compounding all over again. Also, I know if the business fails, I still have the security of the home (LTV about 90% in total right now) and since I am in second position behind the bank, I know that I am going to get paid.

Q

Oct 30th, 2007 @ 4:59 pm
11. The Financial Blogger

I wish I had enough money to do 1st rank mortgage :-D

Actually, one of the biggest risk when you are 2nd rank is that the institution ranked first will sell at a price to cover its cost only in case of default. Therefore, you might have to buy the full 1st rank in order to recuperate your money… sounds pretty scary for individual investors.

The point is that even if you are secured, your security worth not much left once legal fees, Realtor’s fee, maintenance charges and debt is paid off for the owner of the 1st rank

Oct 31st, 2007 @ 12:10 am
12. FourPillars

Qcash - very interesting that you have 2 of these mortgages and the 10% is even more interesting :).

If there is a foreclosure, what kind of legal fees & delay would you anticipate before you get paid?

Mike

Oct 31st, 2007 @ 12:15 am
13. Q Cash

FB

In Canada, mortgagees in a power of sale situation are obligated to maximize the value of the property at the time of sale.

If the mortgagor (even in default) feels the value is too low they can appeal to the courts to get the transaction cancelled.

That is why there are never really great deals under a power of sale or foreclosure in Canada like there are in the states.

Q

Oct 31st, 2007 @ 9:35 am
14. Telly

A bit different but my dad holds the primary mortgage for a multi-unit (22) property he sold earlier this year. I don’t know the full details of the sale but I know that the interest rate was rather high and that the mortgage is only to be held by him short term (somewhere between 5-10 years).

I believe this was done to avoid having to put down 20% as the property was rather expensive (though he did get some form of downpayment).

Again, I don’t have the full details but in a case where the interest rate is high and fairly secure than this could be a good deal, espescially in my dad’s case as he’s retired and considers these payments as a form of income.

Obviously the book FT read will have advice from one perspective - buying. He uses 60-75% of the value of the mortgage as a rule for buying but some will go beyond that. If you are the seller and can capitalize on that (with a high interest rate), you could be on the more advantageous side of the deal.

Oct 31st, 2007 @ 1:43 pm
15. FrugalTrader

So Telly, think your Dad would be interested in selling his mortgage @ a discount? :)

Oct 31st, 2007 @ 1:51 pm
16. The Financial Blogger

Qcash, I did not know about that. But don’t you think that there is still a risk to not get the your full repayment in case of default?

For example, if the guy does some damage to the property before he leaves, chances are that the 1st rank will be able to cover his expenses but not the 2nd rank…

Is there a big market for 2nd rank mtg in Canada?

Oct 31st, 2007 @ 11:05 pm
18. Q Cash

FB

Yes, but remember we are dealing with owners not rentals. Most owners try not to do that, as they are entitled to anything left over after the sale.

Also, keep in mind that you have to be comfortable with the LTV at the time of the mortgage, but property values generally go up too.

FT has asked me to provide a guest blog about my experiences (which I will try to get to him over the weekend) and I can give more details.

As for a big market, I know many many people who try to do the second mortgage at higher rates to avoid paying the CMHC fees on the first.

Q

Nov 1st, 2007 @ 12:31 pm
22. Debt Reduction

I’m thinking this will be a good thing in about 2 years. Until then I would be careful to not invest in any real estate where the total of all leans is greater than 70%, maybe more like 60%.

This has become a touch market!

Nov 10th, 2007 @ 5:12 pm
23. KK

I have a second mortgage to sell if anyone is interested

Apr 28th, 2008 @ 12:27 pm
24. Ed Kelly

This is to K.K, ——–I may be interested in buying your 2nd. What ate the particulars and what is the discount? Thank you—-EK

Apr 28th, 2008 @ 4:08 pm
25. Rob

That author was Charles Givens, and he was a con artist. I don’t think that I would follow any of his advice.

Rob

Aug 11th, 2008 @ 2:44 pm