4 min read
Do You Fund Hard Money Second Mortgages to Cure a Foreclosure on Owner-Occupied First Mortgages?
If you're seeking a hard money second mortgage to cure the foreclosure action on the owner-occupied first mortgage...
The Difference Between Business Purpose and Consumer Purpose Loans
It’s important to first understand the difference between business purpose and consumer purpose loans. I’ve written about this topic in another blog post you should definitely read. I also address this topic over and over on these pages so you can save time and focus your efforts in the right direction.
Business Purpose Hard Money Loans
Nearly all hard money lenders only do business purpose loans, where the use of funds are for a business or investment property. Examples include:
- Investment property: purchase or refinance
- Owner-occupied commercial property loan (warehouse, manufacturing, office, etc.)
- Construction loan for home builder or developer
- Fix-and-flip loan
- Purchasing a business using proceeds from a hard money loan
- Cash-out against a primary residence with proceeds for a specific business purpose
- Investment property renovation
- Business debt consolidation
- Business taxes
- Business partner buyout
- Business judgments and settlements
- Business litigation loan
Summed up, business purpose is for investment properties or mortgages where cash-out funds are going directly to a business account, with the borrower documenting the precise use.
Consumer Purpose Hard Money Loans
A consumer purpose loan is where the use of funds is for personal expenditures. Examples include:
- Primary residences
- Second homes
- Home improvement – primary and second homes
- Debt consolidation – personal debts (credit cards, auto loans, installment loans, etc.)
- Personal income taxes
- College tuition
- Weddings
- Divorce settlements
- Splitting inheritance proceeds
- Personal judgments
- Making bail
- Chapter 13 bankruptcy buyouts
To make a consumer purpose loan, a hard money lender has to go to great lengths to document how the funds are used, and how the consumer can afford the payments. They also have to write the loan for 20 or 30 years, which most hard money lenders don’t like to do (12-month bridge loans are most common in hard money lending). During the underwriting process, the lender is preparing their legal defense in the event that the borrower defaults, initiates foreclosure proceedings, and causes the borrower to sue or file for bankruptcy. Hard money lenders who originate consumer loans are also documenting their future responses to a judge at trial.
As you can see, there’s a lot for a lender to consider when making a consumer purpose loan.
Business purpose loans, on the other hand, don’t have this level of legal liability. The borrowers are usually real estate investors, developers, home builders, or house flippers. They’re using hard money loans for real estate, not personal uses.
This is why I said nearly all hard money loans are for business purposes and very few are for consumer purposes. With consumer purpose loans, the risk to lenders is much higher than a borrower defaulting on payments. Therefore, hard money lenders focus on business purpose loans.
Foreclosure On Your Primary Residence
If you’re in default or foreclosure on a conventional mortgage at 4.00% on your primary residence, a hard money loan at 11.00% is not a viable solution. I wrote a blog post, Hard Money Loan to Stop Foreclosure on Your Primary Residence, covering the ins and outs of alternatives to hard money loans. Here’s a quick summary:
- If the 4.00% loan is in default, it’s hard for a lender to justify a new loan at 11.00%.
- Instead, work with your existing lender on forbearance or loan modification.
- Communicate with your lender – don’t bury your head in the sand!
- Consider selling your house – home values have soared since 2020 and you may net significant proceeds from the sale. Renting instead, with extra money in the bank might be less stressful.
I think it’s better to always first work with your current lender on forbearance or a loan modification. Loan servicers have come a long way since the housing crash of 2007-2010. They’re better at helping borrowers keep their mortgage to avoid foreclosure.
Small Hard Money Second Mortgage to Cure Default
If the first mortgage on a primary residence is 3-6 months in default, a small hard money second mortgage of $10,000 to $20,000 also isn’t a possibility. The main impediment is the income documentation and trial preparation a hard money lender would need to complete. In addition, most lenders have a minimum loan amount of $100K or $200K. Making a small loan is the same amount of work for much less pay. It’s not a wise use of their time.
If you can’t get a forbearance or loan modification, move on to friends and family for help. Ask someone you know for financial assistance.
Foreclosure On An Investment Property
If a borrower is in default on an investment property, they might be able to use a hard money loan to pay off the existing mortgage. However, borrowers can face many challenges and obstacles going this route.
Payment History – One-Off Situation or Long-Term Pattern?
If the current loan has been in and out of foreclosure for a few years, it’s going to be hard to find a hard money lender interested in paying off that loan with a new one. Habits can be hard to break, especially one of frequently being 30, 60, or 90 days late on mortgage payments.
Hard money lenders want to fund a loan and then receive on-time monthly payments – not have to call late borrowers and get an excuse or the runaround. However, if the default was a one-off situation, it’s more likely a hard money lender will consider making a loan to stop the foreclosure.
FCTD has seen both the repeat offenders who are in and out of foreclosure, and the one-off situations where something unexpected happens – like an illness or a large warehouse tenant filing bankruptcy and going out of business. Each of these situations have to be considered for their unique circumstances.
Conclusion
If you’re facing foreclosure on your primary residence, consider several options before pursuing a hard money loan: working with your current lender, asking friends and family for a loan, or simply selling the house. Hard money has the lowest probability of success and should be the last resort – despite what some real estate agents and traditional mortgage brokers think. Likewise for investment property owners: first work with your existing lender to keep that loan in place. If that’s not possible, check with hard money lenders, who may take out a loan for one-off situations, when the borrower is unlucky rather than undisciplined.