Even with widely available financing there may be cases where a seller is asked or wants to create a second trust. Such financing can be both a good marketing tool and a profitable investment. However, sellers should approach second trusts with caution.
There are several distinctions between first and second trusts. A first trust gives the lender an initial claim against the value of the property if the buyer defaults. After, and only after, the first trust has been satisfied can any remaining assets be used to pay off a second trust. Since the second trust represents more risk than a mortgage, the rate of interest is higher. How high the interest goes if determined by the market, negotiations between the parties, and local usury laws.
While mortgages are self-amortizing; that is, through equal montly payments they are eventually paid off, second trusts usually have a balloon payment. In a typical case, second trusts are paid at the rate of $10 per month for each $1,000 fo the note. For a $10,000 note the monthly payment would be $100.
The monthly payment includes both principal and interest. However, second trusts generally are not paid out because the term of the note is too short - usually five, seven, or, in some cases, 10 years. If the interest rate for the note above is 8 per cent, it would take 165.3 months to repay the loan is equal installments. Here, $7,550 would be due at the end of five years, $6,262 at the end of seven years, and, with a 10 year note, the balloon payment would be $3,902.
While second trusts can offer steady income they are not salable at face value. Instead, such trusts are sold at discount with buyers usually seeking effective returns in excess of 14 per cent. This means the $10,000 note cited here would have a cash from a second trust, the seller in this case would have to obtain a note for approximately $12,650.
Sellers who consider second trusts must evaluate their needs carefully. Selling one home to raise cash for another may rule out a second trust. Also, it may be best to sell a home and then buy someone else's second trust at discount. One further consideration is that second trusts are normally not assumable. If the property is sold prior to the term of the note the balance becomes due immediately.
Second trust documents are signed at settlement and recorded by the local jurisdiction as a claim against the property. While settlement attorneys and title companies usually prepare trust forms, it is advisable for the seller's attorney to either write or approve the wording of any second trust agreement. This will assure that the note reflects the best interests of the seller.
Peter G. Miller teaches the course, "Hoe to Sell Your House - With or Without a Broker" through the Consumer Information Institute here.