How can an investor get a junior mortgage loan?
Given that the underwriting standards on investment property loans are often more stringent than for a loan on a primary residence, it is unlikely that an investor will be able to get a second mortgage loan specifically to cover their down payment and closing costs. However, there is a workaround. Investors will often take out a home equity loan or HELOC on one investment property and use the funds to finance the down payment for a new property.
If you're considering this financing option, you're going to need to have a low debt-to-income ratio, high credit score, and plenty of cash reserves. In some cases, you may also need to undergo a waiting period before you can take out a junior lien on an investment property. Once you've been approved for the loan, you will likely also be subject to a higher interest rate.
The stricter underwriting guidelines are largely due to the fact that allowing a second mortgage loan on an investment property vastly increases the level of risk for the lender. In this case, if the borrower is unable to pay all of their debts, they are more likely to prioritize payments on their primary residence as well as payments to the senior lien holder on the investment property.
What investors need to know about being a junior lienholder
For investors, it's also important to recognize that it is possible to invest in subordinated debt. This largely happens in commercial real estate, but it can be an effective way to diversify your portfolio. In general, you can invest in two different types of subordinated debt securities:
- Mezzanine loan: A mezzanine loan is not collateralized by the property itself but by 100% of the borrower's ownership interest in the property. As a result, they often have a simpler and expedited foreclosure process.
- Subordinated "B" notes: On the other hand, subordinate "B" notes are generally secured by the property. As a result, the note holder generally receives payment after a foreclosure sale has taken place and the senior lien holder has been paid in full.
If you're thinking of adding some junior lien mortgage notes to your portfolio, it is crucial to do your research first. In particular, you're going to want to find out about the type of loan, such as a private mortgage or institutional loan, the lien position, the asset class, and the loan performance.
The bottom line on junior mortgages and investing
At the end of the day, junior mortgages can be very useful tools in the hands of savvy real estate investors. Whether you're looking to borrow a second mortgage loan in order to cover the costs of adding a new property to your portfolio or you're hoping to invest in them directly, use this guide to help you get started. Armed with this knowledge, you should have a much better idea of how you can use a junior lien to level up your investment strategy.