A house was being foreclosed by a second mortgage holder. I was contacted by a person who had bought a house with seller financing. The seller carried back an “interest only” third mortgage with a balloon payment behind two loans that he had placed on it when he bought it. The existing second mortgage lien required a balloon payment a month prior to a separate balloon payment that would be due on the third mortgage. The buyer took title subject to the existing level payment, self-amortizing first mortgage.
Both the seller and the buyer were convinced that house values would continue to rise, and that the balloon payments could be paid on time either by financing or by a sale to someone who would refinance the house. Then they both got caught in the combination of the market slow down and higher loan underwriting requirements.
When the due date for the second mortgage balloon came and passed, the lender started the process of foreclosure. The buyer discovered to his dismay that he couldn’t find an institutional lender who would bail him out, so that’s when he turned to me.
I agreed to buy the second mortgage with the balloon payment, and give the owner time to sell the property in return for half interest in the $20,000 equity; but only if the third lien holder (former owner) would agree to the same conditions. He did, and I proceeded to try to buy the defaulted second mortgage loan at full face value.
Then trouble struck: The second mortgage holder was angry because of being forced to go to the expense of a legal foreclosure and refused to enter into any transaction that would help the defaulting borrower. In the climate of multiple weekly foreclosures, I was the only bidder and bought the property for $1 over the existing first and second loan balances.
This was an unintended development that wiped out the $18,000 balloon Note and mortgage of the original seller, and wiped out the $20,000 equity of the person who had first contacted me. At the same time, it delivered me $38,000 in equity in a house that was worth the money, but for which there was no current market value.
My only choice was to rent the house until the market returned. Fortunately, the owner who had been foreclosed agreed to manage the property and to deliver me all the rents until it closed if I would agree to divide all sale profits 50/50 with him. He did a pretty good job. Over the next 17 years, the house was rented to only two tenants who paid an average of $300 per month over all the costs.
When the house finally sold, we divided about $70,000 in net profits
In addition, I received about $60,000 in net rents.
There are several lessons to be learned from this experience: First, look for defaulted junior liens that can be bought and assigned to you. Second, beware of selling property and carrying back junior liens; you could be wiped out if the senior liens were defaulted and you didn’t have the cash with which to defend your position. Third; don’t be afraid to share your future profits with those who have lost their equity through foreclosure if they can provide competent management over the long term; because it may be years before any profit can be realized.
