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I loaned a friend $50,000 and I want to determine the best way to protect my interest if he's foreclosed on.

I loaned a friend $50,000 with a promissory note secured by his home valued at $800,000. He has a first mortgage of $400,000 but is stuggling with payments due to the economy etc. i want to determine best way to protect myself and get my money back if the bank forcloses or he is unable to make future home payments. Should I record this promissory note secured against the property, in case the bank forcloses. Would I be protected. Would I have right to bid or buy the property if they don;t or are unable to pay me on the note. Just want to understand our options and legal position to best protect my note amount owed and his equity in the house. He is trying to sell the house but this may take some time and we don’t want the bank to forclose and or sell the house for their $400,000 1st mortage amount owed and we lose the other equity in the home.

Hopefully you got a deed of trust along with the note. You should record the Deed of Trust - not the note. You should also record a request for notice, so that the first will be required to send you notice if they go to foreclose.

As for protecting yourself if they do foreclose:

  1. As a junior lien holder you may be able to advance payments to the first and add them to the balance. You’ll need to check the agreement you have with your friend - standard form deeds of trust generally allow this.
  2. If you aren’t receiving payments as agreed you could foreclose (you’ll need a deed of trust to do a non-judicial foreclosure, otherwise you’ll have to take him to court for a judicial foreclosure).
  3. If it does go to sale you can bid to at least make sure the purchase amount is higher than the amount you are owed - if you “win”, then you’ll take possession of the property and can try to sell it to recover your money. If you “lose”, your entitled to any excess proceeds (the amount above what was owed to the senior lender), up to the amount you are owed. Note that since you lien is unrecorded you may find that you are now junior to other debts, so you’ll want to make sure you really are next in line or you may have to bid even higher. This option is tough because you’ll need cash to cover the amount of the first, plus the amount of your loan in order to bid… sounds like $450k minimum to protect your position.
    Finally you should hire a competent attorney to make sure your paperwork is in order, your lien is properly recorded, and that you really are in 2nd position as it will significantly increase your chances of not losing your funds, or putting yourself in a position of having to sue your friend to recover the money.

You should have a Trust Deed recorded (or whatever the equivalent is in your state) to actually have your loan secured against the home. If there is still equity in the house, even if the bank forecloses you will still very likely get your money at that point. Whatever is bid on the house beyond what is owed to the first lien holder (i.e. the bank) trickles down to the other lien holders in order of their recorded position. So, if his house is really valued at $800,000 and the bank forecloses, the house will likely sell for significantly more than $400,000. Let’s say it sells for $700,000. In that case, the bank would get their $400,000, you would get your $50,000 (assuming you have recorded a Trust Deed and are in second position), and then the owner would get the remaining $250,000. If there are other recorded liens, they would get paid before the owner. And any lien holders who have a position before yours would get money before you get yours. Of course, if the house is actually worth $800,000, and the owner only owes $400,000 to the bank and $50,000 to you, he would be really stupid to let it go to foreclosure. He should be able to easily do a regular sale. He would avoid having his credit trashed, and he would still come out with a decent chunk of money. But to reiterate: yes, definitely make sure you have a Trust Deed (AKA Deed of Trust) recorded. If that’s not recorded, you loan is not really secured. Thu Jan 5th 2012 at 11:42am

thank you for the response. I am and was in the process of sending my agreement titled “Security Agreement Accompanying Secured Promissory Note” and “Secured Promissory Note” but was not sure if just the Security Agreement is recorded or the Secured Promissory Note as well. Now with your comment to make sure I have a “Deed of Trust” recorded, is this an additioan document that needs to be recorded by myself and who all would need to execute it, myself only or the borrower as well? The property is in Idaho, I am in California. For Idaho - where am I able to get a “Deed of Trust” document ? From a local Title Company Company or possibly online. I am trying to understand and be clear on what I am looking for. Hope this is clear and you can provide a little more direction. Regarding the sale if it sells for more than the 1st mortagage of $400,000, say $700,000 who specifically is responsible for insuring distribution of the excess $300,000 to pay off my recorded note (Deed of Trust) and balance to the existing owner? I agree with your comments and much appreciate your feedback. I agree with the importance of getting the property sold to protect his equity but the market is very soft and financing tight . Thanks again. Fri Jan 6th 2012 at 10:24am

I’d strongly encourage you to hire an attorney in Idaho to review your current documents, and work to make sure you have the right things recorded. I’m not as familiar with Idaho as I am California, but I do believe it is a non-judicial, deed-of-trust based state, so the things stated above should apply. It’s not clear to me that you have the correct documents at all to secure your loan. In a non-judicial foreclosure state, like CA and ID, a “trustee” will handle the foreclosure sale and would be responsible for distribution of the excess proceeds. Note that if there is any dispute over the distribution the trustee will refer it to the court system which could leave the funds tied up for quite some time. Finally - not being able to sell because the “market is very soft and financing is tight”, usually means to me the property is significantly over-priced and the seller (or perhaps even that market in general) hasn’t come to grips with the fact that prices need to drop substantially. A good way to check is to calculate the return on investment vs. rent. For the house to really be worth $800k, net annual rents after all expenses better exceed $40k, and preferably $60k+, otherwise it’s a market that is likely going to see prices get much worse before sales pick up. If he continues to let the property sit overpriced on the market, don’t be surprised to wake up one day to find out there isn’t enough equity to cover your loan. Sean Fri Jan 6th 2012 at 10:40am

I have a copy of a “Deed of Trust” from and Idaho online Title Company but it does not reflect any required signatures at the end of the document, just names of the Grantor, Beneficiary and Trustee (the Title Company) (can I be the named Trustee?) at the beginning and at the end provides for the document to be notorized. Fri Jan 6th 2012 at 10:44am

Brad - it is going to have to be signed by the borrower (grantor) to be valid. You really need to hire an attorney. Shouldn’t cost more than a few hundred dollars. Hopefully the borrower is a good friend because you’ll likely need their cooperation to straighten this out without significant legal fees. Everyone - take note! Don’t ever do what Brad did and lend your friend some money without legal advice. Beyond likely having used the wrong forms and subjecting his interest to other claims by failing to record it, there’s also potentially issues around compliance with TILA, HOEPA and RESPA whereby it seems to me that the federal government is making it illegal for anyone but big banks with lots of lawyers to get decent returns on their money. Sean Fri Jan 6th 2012 at 11:11am

Thanks. I have contacted a title company in Idaho and it will be handled with the Deed of Trust being Recorded. Fri Jan 6th 2012 at 1:48pm