Mortgages and Real Estate :Junior Instruments (Second Mortgages)

A junior mortgage is one which has a lower priority or lien position than a first mortgage. A third or even a fourth mortgage is also classified as a junior mortgage. What established a mortgage as being a junior mortgage is that it was recorded after the first mortgage was recorded and thus its lien position is inferior to the first mortgage.

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Purchase Money Mortgages (PMM)

The term purchase money mortgage has a dual meaning in real estate financing. All mortgage loans for real estate purchases are designated purchase money mortgages by lenders, and thus all the different types of mortgages explained could be classified as purchase money mortgages. The second meaning of the term explains what happens when the buyer does not have the necessary cash and the seller agrees to take back a part of the selling price in the form of a purchase money mortgage. Such a mortgage is ordinarily subordinated to take a second lien position since the primary lender will require a first lien position before making the loan. For the purchaser, this means less cash and possibly an interest rate on the PMM less than if those same dollars were borrowed from a primary lender. The seller can possibly induce a sale not otherwise possible by agreeing to take back a purchase money mortgage. The seller is protected in that a PMM places a lien on the property the same as any other second mortgage.

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Home Improvement Loans

In recent years, one result of increased housing costs and higher market prices has been the relatively fast equity build up for owners of real estate. To an owner, this equity can become a source of capital that can be drawn out of the home for home improvements, personal or business reasons. Numerous commercial banks and finance companies make short term (three to five years) junior mortgages based on a percentage of the homeowner`s equity. Since they are junior mortgages, such loans normally carry an interest rate three or four percentage points above that charged on senior instruments.

Wrap Around Mortgages

As its name implies, a wrap around mortgage (or deed of trust) is a junior mortgage that wraps around an existing first mortgage. It is also called all inclusive trust deed (AITD). This method of obtaining additional capital is often used with commercial property where there is substantial equity in the property and where the existing first mortgage has an attractive low interest rate. By obtaining a wrap around, the borrower receives dollars based on the difference between current market value of the property and the outstanding balance on the first mortgage. The borrower amortizes the wrap around mortgage which now includes the balance of the first mortgage, and the wrap around lender forwards the necessary periodic debt service to the holder of the first mortgage. Thus, the borrower reduces the equity and at the same time obtains an interest rate lower than would be possible through a normal second mortgage. The lender receives the leverage resulting from an interest rate on the wrap around greater than the interest paid to the holder of the first mortgage.

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Example

The sale price is $300,000. There is a mortgage balance of $200,000 payable at 9% interest. The buyer will pay $30,000 cash down and agrees to pay the balance at 11%. By using the wrap around mortgage, the seller can have the buyer agree to a mortgage of $270,000 at 11%; the buyer makes the applicable monthly payment to the seller. The seller, in turn, continues to make payments on the underlying first mortgage which was written at 9%. This means that the seller, in his or her role as a mortgagee, now earns 11% on $70,000 (the difference between the new mortgage of $270,000 and the existing mortgage of $200,000) and 2% on the existing $200,000 loan.

The seller grants a deed to the buyer in the regular way. Note that for this method to work, the original lender must be agreeable to the seller transferring title.

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