How Does a Hard Money Second Mortgage Work?

This article delves into the workings of a hard money second mortgage, starting with the personal and financial items a borrower should prepare before applying, the underwriting process, signing loan docs and post-closing steps. The following is a step-by-step process to help you obtain a private loan against one of your properties in second position. 

Before we start, I want to say that my company, First Capital Trust Deeds (FCTD), has brokered hard money second trust deeds for over a decade. During this time, FCTD has originated several hundred junior liens, mostly in California, where we and most of our lenders and trust deed investors are located. We’ve also originated some seconds in other Western States, which has been our focused lending area.

I mention this because we receive loan requests from all over the country — and oftentimes we can't provide financing against properties in those states. We're not as familiar with non-West Coast markets. And since we’re a mortgage broker, not a mortgage lender, we don’t have final decision-making on loan approvals. However, in time I believe this will change and we’ll be able to provide private money second mortgages in more states. 

Now, onto learning how a hard money second mortgage works.

Application for a Hard Money Second Mortgage

I wrote an article about the requirements borrowers must provide when applying for a hard money second mortgage. In it, I covered the following categories that borrowers are required to submit for underwriting and due diligence conducted by both the mortgage broker and private lender: 

• Loan application, photo ID
• Liquidity — bank and financial statements
• First mortgage information — note and mortgage statement
• Property information including leases, rent roll and confirmation of rents received 
• Entity documents
• Insurance information
• Use of funds
• Exit strategy

Once these items have been received, we move onto underwriting the loan. 

One word of advice — be organized with your personal and financial documents. Label everything accurately so a lender can open the PDF and know exactly what to expect when reviewing the item. It’s a huge time saver and will give your application a leg up moving through the underwriting process.  

Underwriting Process for a Private Money Second Trust Deed

Once we’ve received the documentation above, we review, order reports, and verify all the information. Below is the list of steps taken to underwrite a hard money second mortgage.

• Look for any due-on-sale clauses in the note on the first mortgage that may prohibit a junior lien (common on hard money first mortgages).
• Determine if an inter-creditor agreement is required between first and second mortgage lenders. If so, draft the agreement to be signed by both lenders.
• Review the loan application.
• Order a credit report.
• Order a background check.
• Verify liquid assets.
• Review previous real estate projects to verify the purchase price and exit price match.
• Review the entity documents provided, verifying that it's in good standing and we have all documents associated with the entity. (Sometimes, one entity will be owned by another, or a set of trusts will own an entity.)
• Open title and escrow. 
• Verify payment history on the first mortgage (VOM).
• Check to see if the property is in a FEMA flood zone.
• Contact the insurance company to verify coverage and add the junior lien to the loss payee clause.
• Review the use of funds and exit strategy.

Each loan will have its own unique circumstances including partnership buyout, or cash-out funds to be used to acquire another investment property with a fast approaching deadline that we need to meet. That’s why I emphasize being organized: with your personal and financial documents in place, it will speed up the process. 

Valuation for a Hard Money Second Mortgage

The type of property valuation or appraisal required for a hard money second mortgage depends entirely on the funding source. FCTD works with five types of lenders for hard money loans: individuals, real estate investment groups with a lending division, family offices, mortgage debt funds, and conduit lenders who originate loans that are immediately sold to secondary market investors, often on Wall Street. 

Each of the five types of private lending sources have different requirements for appraising and valuing the property. As a borrower, expect that your property will be evaluated, whether a formal interior-exterior appraisal or simply a desktop review.  

Below are the different appraisal types possible for a hard money second mortgage: 

1. Desktop Review
   FCTD has some lenders that will do a desktop review, looking at MLS listings to see if the property is currently listed for sale. Or, if they live near the property, they'll check Zillow or Redfin and drive by the property.     

2. Site Inspection
   A few of FCTD’s lenders will meet the borrower at the property for inspection. These only take 10-15 minutes, but give the lender a good idea about the property and borrower. We’ve had a few occasions over the years where the lender met the borrower at the property and got the sense that something wasn’t on the up-and-up. Intuition and experience can go a long way to save lenders time and money in the long run.  

3. Broker Price Opinion (BPO)

   Some lenders will order a BPO, using one of two methods. They'll sometimes do a formal BPO through an appraisal management company (AMC). Or, they’ll call a real estate broker they’ve worked with over the years who knows the specific market really well for their insight into the subject property and location.

4. Appraisal
   

   Other lenders, primarily mortgage debt funds and conduit lenders, will require a formal appraisal. This is often a requirement of their fund agreement with investors or with secondary market loan buyers.  

Sign Loan Documents for the Second Mortgage

Once all the underwriting and property valuation is complete and verified, we draft loan documents and schedule an escrow signing. Borrowers can go into the title company or a notary can meet them to sign docs. 

Funding, Recording and Disbursement of Loan Proceeds

After the loan docs have been signed and reviewed for accuracy (we do this every time!), the lender (or lenders in the case of a multi-lender loan) will wire funds to the title company to record the Deed of Trust with the county recorder.  

After recording is confirmed, escrow will disburse the funds to all parties listed on the closing statement. Most of the time, escrow wires funds to recipients. However, in some cases, checks are over-nighted for next-day deposits.

Loan Servicing Account is Opened 

The five different types of private lenders that FCTD works with have their own loan servicing preferences. I’d estimate that 75% of the hard money loans FCTD originates have a loan servicing account with a third party servicer, FCI Lender Services, Inc., in Anaheim, California. In this instance, FCTD handles the loan servicing setup, sending borrowers and lenders DocuSign setup forms within 10-15 days of closing.   

Other lenders, including some family offices and conduit lenders, will service the loans internally. Borrowers will make payments directly to the lender for the entirety of the loan. 

Conclusion

It’s my hope that this article gave you more insight into the workings of a hard money second mortgage. A lot of work goes on behind the scenes to approve, appraise and fund a loan. The better you understand and are prepared for the process, the faster you can get the second trust deed financing you need.