Q: Our rental home in Florida has been rented with an option to purchase for almost two years. The other day, my wife spoke with the real estate agent who informed her that our tenant needed some assistance and asked if we would hold a $10,000 mortgage. Although our present agreement does not have a contingency clause, we are inclined to go along with this proposal.
How do we protect ourselves if we are holding a second trust? Should the mortgage company holding the first trust be given the responsibility to service our loan? Is there a typical agreement form to be utilized in this case?
A: Perhaps one day there will be uniform state laws governing real estate transactions. At the present time, however, each state has its own laws, and they vary considerably. Thus, since I am not familiar with Florida law, I can give you only general advice--and suggest that you contact a real estate attorney in the community where your rental property is situated.
You have to be concerned with such matters as usury, second-mortgage lending laws and procedural technicalities affecting the various mortgage (deed of trust) instruments. For example, there are significant differences as to how the deed of trust should be recorded in the District, Maryland and Virginia. The usury laws in those locales also vary somewhat.
As a general rule, you should consider at least the following:
Cross-collateral provisions. You want to make sure that a default on the first deed of trust (or mortgage) also will be an automatic default on your deed of trust. You want to make sure that the lender of the first mortgage will notify you if the borrower (your purchaser) becomes delinquent on the monthly payments. I suggest that you write the first trust lender to inform them that you hold the second trust and asking them to notify you if your borrower becomes delinquent. Have the lender sign a statement to that effect and return it to you.
Trustees. If you are using a deed of trust, you should select the trustees for the legal documents. The function of a trustee is to release the security if and when the promissory note is paid in full, or to take foreclosure action if the borrower defaults. Again, local law and custom must be reviewed to ensure that the trustee will have the legal authority to foreclose, if necessary. Some local laws, for example, require that the trustee be a resident of the state in which the property is situated.
Collections. I strongly recommend that you establish some collection procedure. It may be that the holder of the first deed of trust will service your loan also. Having to make only one payment will be convenient for the borrower. However, you should check this out in advance with that lender, because they may not be equipped for such services. A local bank or savings and loan association also will provide these services, and often the fee is waived if you maintain an account at that financial institution.
Insurance. You want to make sure that the borrower obtains adequate homeowner insurance, protecting not only the first lender but also covering your interest in the property. At settlement, the borrower should give you a copy of the insurance policy, which should have your name listed as a beneficiary. You also should require in the deed of trust and promissory note that the borrower yearly furnish you proof that the insurance and real estate taxes have been paid.
These are but a few of the protections needed when taking back a second deed of trust. You also want to make sure that the borrower has good credit; your real estate broker should assist you in evaluating credit information.
It cannot be repeated too often that professional assistance is necessary, especially when you are dealing with out-of-town transactions.