Tuesday, 19 September 2017

Second Trust Pitfalls

Written by Posted On Wednesday, 28 December 2016 20:16

Question: I am interested in purchasing second trusts, since I have been told this is a lucrative investment. Can you confirm this, and are there any precautions to take?

Answer: Second trusts can be quite lucrative, if you know what you are doing. They can also be disastrous, since there are many potential pitfalls.

Second trusts generally carry a higher rate of return than you can get by putting your money in a bank savings account, especially in today's economy.

A deed of trust is like a mortgage. When a homeowner borrows money, and pledges the house as security in the event of non-payment of the loan obligation, the lender needs some written documentation for this security.

The borrower signs a deed of trust, in effect giving legal title to the house to a trustee named by the lender until the loan is paid in full. In the event the loan is not paid, the lender can direct the trustee to foreclose on the property. Generally speaking, court action is not necessary and the property can be sold at auction.

While the rules are different all over the country, the concept of a deed of trust makes foreclosure much quicker and less complicated for the lender. And when the loan is paid off, the trustees must release their interests in the property at the local land records office.

The so-called first deed of trust is usually put on by the financial institution that makes the original home loan. Any subsequent loan for which the property is pledged is considered a subordinate loan, and may or may not have the same security as a first deed of trust.

This does not mean, however, that a second deed of trust is not a good investment.

If, for example, the house is worth $400,000 and the first trust is only $150,000, there is ample security for a second deed of trust of an additional $100,000.. If, on the other hand, the first trust on the house is $300,000, I would caution anyone against purchasing or placing a second trust on the property in any amount.

Why? Because if you are the holder of a second deed of trust and you have to foreclose on the property, the first trust holder might also institute foreclosure proceedings. If the house does not sell at auction for more than the amount of the first trust, usually the subordinate lienholders lose out. Of course, they can always sue the borrower directly, but if there is no money, and no security, the suit may be a useless exercise.

Thus, one begins to see the necessity of carefully analyzing second trusts.

I have seen too many situations where fraudulent individuals have sold worthless pieces of paper they called "deeds of trust." The security for these so-called deeds of trust were non-existent

houses or the deeds of trust were never recorded and did not create a valid security interest in the houses.

If you still want to purchase second trusts, here are some suggestions to protect your investment:

  1. Get that dream of making a fortune out of your mind, and sit down and analyze the facts of each particular transaction.
  2. Seek professional assistance. Your accountant can advise you on the tax and investment ramifications of a second trust, and your attorney should be consulted to determine the validity of the legal documents.
  3. Obtain a credit report on the borrower (the maker) who has signed the deed of trust.
  4. Obtain a title report; you want to make sure you really will be in second position.
  5. Obtain the original recorder's receipt indicating that the deed of trust has in fact been recorded among the Land Records.
  6. Try to get an appraisal of the property, so that you can determine -- on your own and not under the influence of the seller of the trust -- whether there is any real security for your potential purchase.
  7. Finally, don't give cash (or certified checks) to strangers in the street, or to those who come to your house based on an advertisement in the newspaper. Insist that the entire transaction take place at a professional's office, whether at your bank, a title company, or in your own lawyer's office.
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Benny L. Kass

Author of the weekly Housing Counsel column with The Washington Post for nearly 30 years, Benny Kass is the senior partner with the Washington, DC law firm of Kass, Mitek & Kass, PLLC and a specialist in such real estate legal areas as commercial and residential financing, closings, foreclosures and workouts.

Mr. Kass is a Charter Member of the College of Community Association Attorneys, and has written extensively about community association issues. In addition, he is a life member of the National Conference of Commissioners on Uniform State Laws. In this capacity, he has been involved in the development of almost all of the Commission’s real estate laws, including the Uniform Common Interest Ownership Act which has been adopted in many states.


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