Perhaps you made a few private money loans last year–second or even third deeds of trust and you made those loans under the assumption that you were doing so at a Loan to Value Ratio of 80%.
Trust deed investors in the private money market often rely far more on the LTV ratio than the borrower’s credit history due to the very nature of the private money. Usually the borrowers have already been flagged as too great of a credit risk by major banks, have poor FICO scores and are willing to pay higher interest rates to get their loan. Accordingly, the appraisal value of the borrower’s property is the biggest safety net for lenders.
California real estate values have been phenomenal over the last decade and the rising values have protected trust deed investors and lenders from taking back properties and borrowers from facing foreclosure of filing bankruptcy.
However, there is evidence that even in California, the market is cooling in certain regions. What if your appraisal report was overly rosy in the first place? This creates certain problems. If you made a loan of $100k on a property that you thought was worth $1M, and there is a loan to Washington Mutual ahead of you for $700k–you’re at 80%LTV. But what if the appraisal was too high? Say it was off by 10%, and the property was worth closer to $900k.
Well, now your investment is on a far more narrow margin. Perhaps the market softens further and the property is now only worth $850k.
Now if the borrower stops making payments to the first, you will be facing a situation where you have advance to the senior. Instead of being into the loan for $100k, you are advancing $20k or more to bring the loan current and must contemplate bringing your own foreclosure proceedings!
Even worse, if you are under water on this loan, you could be facing a deficiency situation. This means that you may have to consider a Judicial Foreclosure instead of a private Trustee’s Sale. This option is only available assuming you did not make a purchase money loan. California’s anti-deficiency statute prevents lenders from going after a borrower beyond the equity in the property on purchase money loans.
Judicial foreclosures take far longer, but are the best alternative if you feel that the fair market value of the property has fallen dramatically.