Foreclosures and Second Mortgages Fit Nicely Into IRA’s
Now that we know how a foreclosure auction works, it’s time to learn how to invest your IRA in a 2nd Mortgage. As we discussed in the last blog, a first mortgage is usually considered the first position lien and additional mortgages are considered inferior liens. This means that the first mortgage will be paid first and the other mortgages will only get paid if there is money left for them.
Second Mortgages are Very Inexpensive
For many financial institutions, 2nd mortgages on foreclosures are considered pretty much worthless. They are of the opinion that it’s pretty unlikely that someone is going to come in and bid enough to pay off the first mortgage and enough to pay off the 2nd mortgage as well. This makes them fairly inexpensive to purchase. Depending on the financial institution and the property, you can sometimes purchase them for 10-20 cents on the dollar.
Has the Bank Already Written-Off the Loan
In the example that we were given in my class last week, the investor called the bank to offer to purchase the second mortgage. The woman at the bank was having a hard time finding the loan and finally told him she couldn’t find it because they bank had already written off the loan. This was an immediate cue to the investor that he could lower his already low offering price. In the example, he rounded the numbers to make it easier to understand. He said he purchased the 2nd mortgage that had a face value of $10,000 for $1,000. The 2nd mortgage also has $800 in back payments owed, making the total value of the 2nd mortgage $10,800.
Is This Contract Good Enough to Own Personally?
This is my best advice that I can give to you when purchasing real estate debt: Never buy a contract on anything that you wouldn’t want to own, if you had to take the property. There are many times when investing in mortgages, deeds of trust or real estate contracts that you may have to take the property. Do not buy a contract on anything that you think would be difficult to sell if you ended up with the property.
Ok, let’s go back to our example from yesterday. We had a property worth $150,000 with a first mortgage of $50,000 and $5,000 owed for back payments. Our investor friend now owns the second mortgage, which is worth $10,000 on paper, but he purchased it for $1,000. There is also $800 in back payments owed on the 2nd mortgage. So, here’s the breakdown of what will be paid at the auction and the order that it will be paid:
$50,000 – first mortgage
$5,000 – back payments owed on first mortgage
$10,000 – second mortgage
$800 – back payments owed on second mortgage
Be Aware of These 3 Possibilities
Now it’s time to go to the auction. At this point, there are three things that can end up happening. First, the owner of the foreclosed property could come back and make up all the late payments, ending the foreclosure. If this happens, you would be paid your $800 that he owes in back payments on the second mortgage. This would pay back all but $200 of your principle and he would continue to pay you monthly payments on the $10,000 mortgage. Let’s say for instance that he has 10 years left on the 2nd mortgage and he is paying 5% interest. This means that your IRA would receive $106.07 payments every month for the next 120 months. Not a bad return on a $200 investment!
What Happens to My 2nd Mortgage if the Property Goes to Auction?
In the next two scenarios, the property actually goes to auction. Since you are the 2nd mortgage holder, you will want to drive the bid up to $65,800 in order to pay the 1st mortgage, back payments to the 1st, the 2nd mortgage and back payments to the 2nd. There’s a bit of a gamble at this point. If you don’t have the $65,800 in your IRA to pay that price, you better pray that someone else out bids you. However, if you have the money in your IRA and no one out bids you at $65,800, you will get the property for that price. At this point, you will have $65,800 invested in a property that is worth $150,000. If you are able to turn around and sell it at this price with no other expenses, you would earn a profit of $84,200. I hardly think you would complain about a return like that.
…auctions of seized Real Property for sale throughout the United States and Puerto Rico and includes single and multi-family residences; commercial and residential land; commercial buildings and warehouses; and operating businesses. These properties have been seized and forfeited due to violations of federal laws enforced by the U.S. Department of the Treasury. www.treasury.gov.
What If I Get Outbid at the Auction?
The last thing that can happen is in my opinion, the best case scenario. You bid $65,800 and you are out bid at the auction. This means that you will receive $10,800 (the value of the 2nd mortgage plus the back payments due). This means you made a $9,800 profit with the least amount of effort and your money is now liquid again and ready to invest in something new.
Practice, Practice, Practice Makes Perfect
Sounds easy, right? Well, it’s not. It takes a lot of planning and practice. The guys that you see down at the courthouse steps bidding on these foreclosures know exactly what they’re doing and they can spot a “newbie” from a mile away. Do some research and don’t expect to come into one of these auctions unprepared. If you can master the skills needed to do deals like these, you’ll be set for life. Please remember that this is a very general example and there may be other steps involved. If this is something that you are interested in doing, I would suggest finding a good attorney and asking lots of questions.
Please remember that Sunwest Trust does not give any investment advice or endorse any investment products. Make sure to speak with a CPA or tax professional before doing any investments in your IRA.