Second lien or a signature: what actually holds a gap piece together

Record the lien. Not because foreclosing on it is a good plan, it usually isn't, but because a recorded lien is how you get paid on the good outcome. When the property sells or refinances, title pulls a payoff on everything of record. An unrecorded promise gets paid only if the borrower remembers you after closing. Most of my thinking about gap pieces is about the sale, not the default, and the lien is the piece that works at the sale.

Every gap deal I've heard about that got paid back got paid because the borrower wanted to keep borrowing. That makes me think the guarantee and the relationship do the work and the lien is decoration.

Though reading @tender's point about title pulling payoffs, I think I was confusing "what made him pay" with "how the money physically moved." Those aren't the same question.

I'm still lost on one thing. Is a second lien the same as an assignment of the sale proceeds, or are those two different documents doing similar jobs? I've seen both mentioned and I can't tell if you'd ever want both.

@vellum they're different. A recorded second deed of trust or mortgage puts you on title behind the senior. An assignment of proceeds is a contract claim on money, and whether title honors it depends on the escrow company and on state practice, so it's weaker on its own.

The thing to read before either one is the senior's loan documents. Plenty of hard money notes say the borrower can't grant junior liens without written consent, and recording one anyway can be an event of default under the senior loan. So your "protection" can be the thing that blows up the deal you're protecting. Ask the borrower for the senior's docs and get consent in writing, or don't record. Whether a particular clause is enforceable the way it reads is a question for a lawyer in that state.

The clauses I care about aren't the lien grant. They're notice and cure. If the senior can default the borrower and start a foreclosure without ever telling me, my lien is a lottery ticket. If I get written notice of borrower default and a defined window to cure by making the senior's payments, I have a real decision to make and time to make it.

Second one is payoff notice. I want the senior obligated to give me a payoff statement on request. Without that I can't tell whether my cushion still exists after eight months of accrued interest and protective advances.

You're asking one question as if it were one question. The lien determines what you recover if things break. The exit determines whether you ever need to recover. They price differently and you have to underwrite both.

On a small piece I'd rather have a mediocre lien behind a senior with a 65% loan amount and a borrower with a signed refinance term sheet than a perfect lien behind a senior at 80% of a hopeful ARV. The cushion is arithmetic, so run it at a distressed number, something like 70 or 75 cents on the ARV you actually believe, and see whether your position survives.

Numbers, since nobody's put any up. Say ARV 520k, senior funds 400k across purchase and rehab, you put in 60k behind it. Total debt 460k. At a distressed 75% of ARV you're looking at 390k of gross proceeds, call it 360k after costs. The senior takes all of it and is still short. Your 60k is gone at that point and the guarantee is the only thing left.

So the lien is doing nothing for you in that scenario. It matters in the normal scenario where the thing sells at 500k and the payoff goes out in order. That's the honest split. Tell me where the math is wrong.

Before any of this, pay for a title search and read it yourself. On a small deal I looked at as a passive piece, the borrower had a judgment recorded from an old business and had described himself as clean. He wasn't lying in his head, he'd forgotten. That one search changed the price I would have accepted, and it cost less than a set of loan docs.

@kestrel your poll has a "both or nothing" option and that's where I'd land, but I want to know what people give up to get both. If I insist on a recorded lien plus a guarantee plus notice and cure from the senior, does the deal just go to the lender who asks for less?

@sable yes, sometimes, and the speed of your yes is part of what you're selling.

One thing from studying for my license that surprised me: how you'd enforce a junior lien is very state specific, judicial foreclosure states versus non judicial, timelines, and whether a deficiency judgment against the borrower is even available. Don't assume what you read on a national blog applies where the property sits. Ask a local attorney what a junior position actually gets to do there.

Every gap quote I've collected for a list I'm still building wanted the recorded second and the personal guarantee. Not one offered me the choice.

If the borrower resists recording, that's information, and it's usually about the senior's consent clause @warrant mentioned.

The part that stops me is fixed cost. On a 45k piece, docs drawn by a real attorney plus recording plus a title search ran a friend of mine somewhere around 2,200 to 2,800 depending on the state. At 13% that's the first two and a half months of interest before you've earned anything. It's why people talk themselves into a handshake, and I understand the temptation even though I think it's a mistake.

Reading @ledger's math I caught myself wanting to argue with the 75% while leaving the 400k senior alone. The senior number is the one I'd actually be trusting, since it's someone else's underwriting of both the purchase and the rehab budget. I've been analyzing this for months and that's the first thing I've found that changes how I'd size a gap piece.

I want the version where I can say out loud what I get in a default and be right about it. If the answer is "I get to sue a guy," that's not a lien-versus-signature question, that's a no.

One thing to add for anyone tempted by junior pieces on land instead of houses. No rent, no rehab that creates value on a schedule, and an exit that depends on a buyer or an entitlement showing up. I've held ground for eleven years happily as an owner. I wouldn't want to be second in line on it for nine months at any rate.