Stand Alone versus Piggyback Second Trust Deeds

Second Trust Deeds are something few real estate loan officers really understand well, mostly because the good ones don't make much money on them. Predatory lending laws in most states, limiting total compensation and total expenses to a given percentage of the loan amount, mean that brokers usually can't make enough to pay their expenses unless there's a first trust deed involved as well. Direct lenders can, because neither the premium they receive on the secondary market nor the interest rate is usually restricted. As a result, many direct lenders can get away with highly inflated rates on second mortgages. Most of the people who approach them won't know any better. I've lost count of the number of fourteen and sixteen percent rates I've seen, when eleven is a rotten rate for a sub-prime borrower. But if you will shop around, second mortgages can be found at surprisingly low rates and surprisingly low cost. If you've got decent credit and a verifiable source of income, fixed rate Home Equity Loans can be had under 8%, and variable rate Home Equity Lines of Credit can be found for 8 to 8.25%. Even sub-prime borrowers can usually find something around 11% if they'll look a little bit.

Second (and Third) Mortgages come in two basic flavors. If you get the proceeds all at once, they are typically fixed rate Home Equity Loans. These are essentially traditional loans. There are also Home Equity Lines of Credit, where you are approved for up to a certain amount, and you can take distributions any time during a draw period that varies from five to ten years in length. These work more like credit cards, albeit secured by real estate so you do get better rates. You pay interest only on the the outstanding balance at any given time. If you pay it down during the draw period, you can then take it out again.

Once upon a time, both products typically had all of the closing costs that first mortgages did. In the last few years, this has changed, largely driven by competition from credit unions, and I always suspected that second mortgages was why the banking industry was lobbying for restricting credit union membership a few years ago.

There are also two styles of obtaining a second mortgage. "Stand Alone" Second Trust Deeds are done on their own; when they are done in conjunction with a First Trust Deed, they are called "Piggyback" loans. With their popularization as a way of avoiding Private Mortgage Insurance (PMI) on low down payment purchases, pretty much every lender in my database does piggyback seconds. However, only about half will do stand alone seconds. With the regulations the way they are, even the higher interest rates are not attractive enough to get them to do the loan, because it takes basically the same amount of work.

Because "piggybacks" are done in conjunction with first mortgages, everybody wants them and everybody does them. Additional lender charges can be small to non-existent. They benefit from having the first done at the same time, and since all that work has already been done for the first, the additional work is kind of minimal. Whether they're a broker or direct lender, they make enough on the first that they don't have to charge as much for a second.

Good "stand alones" are harder to find. For instance, here in California, predatory lending laws limit both total broker compensation and total costs of the loan to six percent, but it still costs about $3500 to do the loan unless the lender relaxes one or more of the traditional requirements. For brokers, this means that they can't pay for it via a higher rate to the consumer, either. If the loan is $50,000, $3500 is seven percent of the loan amount. If brokers try to make it up via yield spread (which is legally considered a cost even though it is not), Section 32 of the Real Estate Code limiting total broker compensation to six percent kicks in, and they cannot do it because theoretical costs exceed what they are legally allowed to make. Note that this limitation does not apply to direct lenders, as their eventual premium on the secondary market is not regulated, and the amount of interest they receive if they hold the note is only subject to very weak governance rules. Upshot: Stand alone second mortgages, unlike first mortgages, are a very hard area for brokers to compete well in. I've got a couple internet based lenders for higher loan amounts (about $75,000 and up), but for smaller loans than that I will usually tell folks straight up that credit unions are likely to give a better deal than I can. For first mortgages, or firsts with piggyback seconds, that situation is reversed.

In some certain situations, due to the low cost of doing second mortgages, I can actually get a client a better loan by doing a purchase money loan under a program traditionally associated with stand alone second trust deeds. With some credit unions and major lenders offering them at 8% or even under, and up to $500,000 with minimal paperwork requirements and low to zero closing costs to the client, it can be a good way to get someone who cannot qualify full documentation anyway enough money a loan for a low end property, particularly if they are making a substantial down payment. If you're buying a $150,000 condo, avoiding the $3500 to $4000 for closing costs associated with a first mortgage can cut your effective interest rate for a loan you keep two to three years by about one percent.

One final note for this update: Right now second mortgages are only going up to about ninety percent loan to value ratio, period. Absolutely nobody is doing them for situations with less than 10% equity. I was saying until recently that the only way to get a loan with less than ten percent down payment was a single loan with PMI, but even first mortgages above 90% of value are rare, not subject to much competition right now, and even so they will not go above 95% of value, leaving government guaranteed loans (VA and FHA) as the only way to reliably get low down payment loans. Many municipalities also have first time buyer assistance that takes the form of a second trust deed, but the budget for those programs is notoriously limited.

Caveat Emptor

Original article here