The goal for many private lenders is to make a return on investment better than CD rates. If you chose the real estate investment wisely, you could stand to make more than CD rates, which is currently 2.39% for a 5 year term offered by Ally Bank. Also to note with the volatility of the stock market, if you continue to invest in the stock market, then you will need to have more resolve than in previous years. But with growth comes a little pain, does it have to be that way? Short answer, no.
A private lender, with an investment secured by realty, may realize a profitable and safe return on investment. Safe can be accomplished by being the first lien holder or as close as you can be to being the first lien holder.
As a second or third lien holder, a default can wipe-out your investment if the first lien holder files foreclosure first. This isn’t to say that the second and third lien holder cannot file foreclosure if they are defaulted on to protect their interest in the property. Most defaults begin with the lesser liens than with the primary.
So if you are the second or third lien holder then you can proceed with foreclosure per the contract you have with the borrower. The loan servicing company can help with the process of foreclosure. After filing foreclosure on the property, as the second or third lien holder you will have to begin making payments to the first lien holder or suffer foreclosure. If the first loan has become delinquent then you will have to negotiate to bring the first loan current.
If you are the third lien holder on a property, you still can file foreclosure and you may be able to buy out the second lien holder’s position to make your interest in the property more stable, and if you can acquire the first lien holder’s note, then that would make you investment in the property even more stable.
Being the first lien holder not only yields you a better return on investment, but can also give your investment better stability.
Foreclosure on a bad loan is not the only option. As a private lender you can allow the borrower to have another entity assume the loan. So instead filing foreclosure, if you or the borrower can find someone else to assume the loan, and use the down payment to bring all liens current, then that would be a win—win situation without the cost of court. Being a private lender gives the flexibility to do more than just a standard few things as long as it is agreed upon by all involved parties.
Another option as a private lender is to allow the borrower to exercise a deed-in-lieu of foreclosure. This can also avoid costly legal fees and you can either sell the defaulted note, or property.
Quick recap on what to do if the loan goes bad
- Be the first lien holder or as close to being the first lien holder
- Use a loan servicing company
- Have contracts in place for the what if’s
- Allow the loan to be assumable
- Use deed-in-lieu of foreclosure over a traditional foreclosure
Covering your downside can make all the difference in having an upside in passive income.