Have you ever had your lien wiped out when the first lien foreclosed? In this episode, Keith Baker shows you a way to recover your loss. He talks about a tool you can use as a private lender – your right to sue for a deficiency judgment. Sharing from his own experience of having to get a ruling and suing a borrower, Keith also names a couple of things you need to check and prepare when getting a deficiency judgment.
If you’re looking for practical tips and advice on mitigating risk in private mortgage lending, then you are in the right place. If you also want to learn from my mistakes so that you can avoid them, then have a seat because this show is created for those who are looking to take control of their financial future and diversify their investments without banks and Wall Street or toilets, tenants and termites. I’d like to create a tribe of private lenders that act as the bank to active real estate investors and change not only the lending landscape but also the landscape and the landscape and the methods in which we teach our children about money. Together we can all prosper without the too big to fail banking systems.
Let’s face it, the world is in flux and it’s time for some radical acceptance of some alternative ways of making money, legal, ethical and moral. I want you to think about this for a second. When economies go into recession, the money supply gets tight. Banks aren’t as willing to loan as much or they’re not willing to loan to risky borrowers. One thing that banks have over private lenders is the multiplier. If a private lender has $100,000 in an account, that’s all that private lender, he or she, can lend. It’s this $100,000. However, if a bank gets $100,000 in deposits, the federal government allows it to loan in some cases up to $1 million or more and that’s a multiplier. If you have $100,000, the federal government will allow you to loan $1 million. That’s a ten times multiplier.
In recessions, those multipliers are reduced. When they reduce, the money supply gets tight and banks stop lending to people who have no business. First off, the first people are the ones that have no business borrowing money on properties they can’t afford. It trickles down. It tightens up all around. In deep recessions, they will only loan you money if you don’t need it. That’s the best position to be in credit-wise. It’s to not need money because banks will be coming after you left and right with all types of offers. When the banks won’t lend to real estate investors, I will and this is something I should clarify a little bit. I will loan in my backyard market and others if I’m comfortable with my level of knowledge in that particular market. Because when everyone’s running for cover, CNBC, CNN, NBC, Fox and all the faux news and everybody else, it says, “Run for the exits.”
When there is blood in the streets, that is the moment when you want to lend. As a private lender, that’s when you’re ready to go because that’s when the sweet deals will be created. Those are the deals that I want to lend on. Because a good and well-seasoned active investor with private lenders on speed dial will be able to close fast. When the economy sucks and your borrower can close within two weeks on a property, they usually get a good deal. What I’m saying is it lowers the loan-to-value. Let’s say if the house after it’s fixed up, the after repaired value is $100,000. In tight economic times, a $100,000 house that needs $10,000 in repairs to get it up to $100,000, that investor can get it for $50,000 or $40,000 all-in.
A good and well-seasoned active investor with private lenders on speed will be able to close fast.
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The amount of money that you’re loaning, your loan to the ARV goes down. That is what helps mitigate the risk of the investment because all investments have risks. The lower the LTV, the more room for error you’re allowing your investor to maybe over-improve the property just a little or if it takes a little longer to sell. Because in recessions, houses don’t sell very fast. Instead of a three to four-month flip, maybe you’re looking at eight to twelve months. That lower LTV gives you that room for error. It gives you that risk mitigation and allows and forgives a lot of sins. That’s why when the recession does come and banks aren’t going to lend, that’s why I’m trying to build this tribe of lenders. I want to thank you for being a part of that tribe because when it hits the fan, we’re all going to be ready and we’re all going to make some money.
I wanted to speak to you on deficiency judgments, which goes hand in hand with your due diligence.
I published that I lost $18,000 on a second lien because I did not perform my due diligence. I trusted a friend. Never trust, always verify. A lot of people say, “You’re very forgiving,” but the truth be told is I didn’t do my due diligence. It’s on me. It’s my fault and it’s a lesson learned. It’s a lesson I hope I shared with you and that you guys take to heart. In Texas where I lend mostly, we have the notion of deficiency judgments. What that means is that since my second position lien was never paid and the first position foreclosed and wiped me out, I can now sue that borrower for that $18,000 and get a judgment, which is not that difficult to get.
It’s straight forward. I have the promissory note, I have the deed of trust and I have the court documents where my lien was wiped out when the first lien foreclosed. Let’s say that I’ve learned my lesson and I should have done better. However, I inquired. I found the attorney who foreclosed on the first lien and I reached out to that attorney and I said, “I have the second lien.” They were unaware, which tells me they didn’t do a proper title search, but they don’t need to when you’re foreclosing. All I need to do is go file your paperwork with the county clerk. However, it was my fault.
A lot of landlords get sued by tenants who know how to game the system.
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I reached out to this attorney. I have an $18,000 second position lien on a house that has now been wiped out because I didn’t do my due diligence and trusted a friend. I reached out to this attorney. He emailed me later in that same afternoon saying he was very busy. I’ve got the email and I’m going to include it here to give you an idea of what we’re talking about. The deficiency judgment is this. I lost my second position lien when the first lien foreclosed. I can go to court and sue that borrower and get a deficiency judgment against them saying, “You owe me $18,000.” Usually, the court will attach it to a piece of property or something else. Check your local jurisdictions, but it’s good for seven to ten years. After that second to ten years, I can refile to have a judgment. A judgment is a kiss of death on a real estate investor because I won’t loan to anyone who has a judgment against them except for landlords. If the tenant is the landlord, I pretty much forgive that.
I’m not saying it’s right or wrong; it’s just the way I operate. A lot of landlords get sued by tenants who know how to game the system. You can either have a crappy landlord if they have judgments against them or you can have a very good one whose tenants are trying to game the system. You got to figure it out. Nonetheless, this deficiency judgment, I have the option to file this lawsuit against the borrower individually for the $18,000 plus interest and court costs. I’m thinking about doing that. Even though as a friend and they said they’ll pay me back, they said that when they signed the promissory note. For me, in a business situation, I’m thinking about going ahead.
However, this is the email from the attorney that handled the foreclosure on the first lien. If there are any attorneys out there who work pro bono or on the cheap in Texas, let me know. I’ll be more than happy to throw this your way and maybe even invite you on the show. It says, “Mr. Baker, I apologize for the delay. It was a very busy lien deadline.” I emailed him around the 15th of the month, which in Texas is the deadline for filing lawsuits on liens. He also needed to get some input from his client to see whether the lender for the first position wanted to go after and pursue a deficiency judgment, in which case he could not represent me because I’d be a conflict of interest. However, that borrower has said, “No, I’m not going to pursue a deficiency judgment. There’s nothing preventing this attorney from representing me. That leaves that attorney free to help me.”
He states that his client mentioned that, “My borrower has no assets from which to recover a deficiency,” which is legal code for, “If you pay me the money, I’ll fight this for you, but I’m not doing it on contingency,” which means attorneys will work either on retainer. You pay the money upfront to handle a case. On contingency, they’ll get 35%, 50% of any judgment or anything that’s awarded to that attorney’s clients. What he’s telling me is that my borrower doesn’t have any assets in their name from which I can recover a deficiency. He goes on, “I do not have any personal knowledge of the matter, but I figured I would relay the information.” What he’s telling me is “I’ll take your money, but don’t expect great results.” That’s what I take from this.
The two cheapest people you can have on your team as a private lender are a good attorney and a good CPA.
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It says, “If you would still like to proceed, please send me a copy of the promissory note and deed of trust.” I have a copy of the recorded deed of trust but has been redacted to remove account numbers because I loaned out of my self-directed IRA, “Also, please send me a copy of any notice of default intent to accelerate and acceleration if notices have not been sent pursuant to the note. There may be some pre-lawsuit notices which should be sent.” That’s standard. You got to let the borrower you’re going to accelerate the loan. They haven’t satisfied the conditions of the loan. Therefore, as a lender, you have the right to accelerate the loan, call the loan due, foreclose, get my money or take the property back.
“I would still like to send a demand letter before filing suit. I will need to know the balance owing to the extent. The information is not included in any notices to the borrower. In addition, I will need a current address for the borrower to send any notices and have the citation served once the lawsuit is filed.” That’s pretty straightforward. In a normal legalese, we need the documents by which the borrower agreed to repay. I will have to show the record where the borrower failed to repay and every payment that was made. “Here’s the deficiency, here’s where they’ve not held up to their end of the bargain so I can foreclose.” This is where it gets interesting because remember I lost $18,000 principal plus interest and legal fees in general.
The lawyer goes on to say, “To proceed with filing the lawsuit for the balance due on the note, I will need to get a $2,000 retainer from you.” When I spoke to this attorney on the phone, it was $1,000. In all fairness, that the attorney was shooting from the hip, because I put that attorney on the spot and said, “You’re handling the first foreclosure. Why don’t you do a deficiency judgment for me? I want to file for deficiency.” This attorney was like, “I’ve come to them.” They shoot him from $1,000, and now it’s $2,000 and I haven’t shopped this around yet. Maybe I will, I’m going to bring it back on. I should shop it around a little bit to a few attorneys and then come back with some prices. However, this particular law firm, all they do is real estate. That’s it. They’re very specialized. The two cheapest people you can have on your team are a good attorney and a good CPA. I know everyone hates attorneys, myself included. I’ve got some friends that are attorneys, but when you need them, you need them. You need a good one and you pay for good work. I’m considering it on an $18,000 loss.
I don’t know if I’m going to do it. Let me continue reading from this note. “Our hourly rates are $200 to $250 per hour and everything is billed on that hourly basis.” The court filing and service costs for the lawsuit will between be between $400 and $500. I’m looking at about $2,500 to file this deficiency judgment. Continuing on from the email, “There will be attorney’s fees to prepare the lawsuit and send any pre-lawsuit notices.” That $2,000 does not include any demand letters, notice to accelerate or acceleration letters. If you are a private lender who does not have a whole lot of money, I would suggest getting with somebody, figuring out, sending demand letters and doing that on your own before the attorney files.
Never trust, always verify.
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What I am doing is also trying to figure out if I can do this on my own. Unfortunately, $18,000 is too much to sue somebody in small claims court in Texas. I’ll have to do it at the county level and most likely get an attorney. Right out of the gate, we’re at $2,500 plus additional fees. Let’s call it $3,000 to file this lawsuit, a deficiency judgment of which I’ll never see again. Let me go back to the reading. “In the event there is no answer to the lawsuit, I will hopefully be able to get a default judgment with relatively minimal fees. We can discuss what to expect if you would like to proceed. Please contact me at your convenience so we can discuss your claim.”
It’s a straightforward letter from an attorney. It’s rare but that’s where I’m at. I’m trying to decide if I’m going to sue a friend of mine for a deficiency judgment. I am well within my rights to do so. I have loaned money to a borrower with conditions. Those conditions were not met and I have the right to file a deficiency judgment or sue for that. I could go against the personal residence, perhaps a vehicle. Most real estate investors, this particular borrower was very frugal that they don’t pay the loans back. I’m torn. On one side, the liberal on me is like, “Give this person a chance. They’ve made a mistake.” The conservative side is saying, “You do what’s within your rights.” The middle road is and a very cerebral fashion of thinking, “I loaned money. I stood up to my end of the bargain. I provided the money for the loan and the borrower has not repaid.”
This has been a great therapy session for me. I wish it was free, but I think I will proceed even if it does cost me $3,000 or my IRA, $3,000. There’s one thing I do want to say about deficiency judgments. They’re not allowed in every state in the United States. This is my understanding. Check with your local attorneys, check with your local ordinances or jurisdictions. Never trust, always verify. I’m going to tell you something. You need to go verify. That’s your job. I won’t tell you; you got to go figure this stuff out. I’m not saying you shouldn’t loan in these states, I’m just letting you know that this is not available to everyone who’s reading this. Those states that do not allow deficiency judgments, to my understanding are Alaska, Arizona, California, Connecticut, Hawaii, Iowa, Minnesota, Montana, Nevada, New Mexico, North Carolina, North Dakota, Oregon, Washington and Wisconsin.
This is not a deterrent against private lending in these states. Just know that you can’t go get a deficiency judgment. I will relay this with more information as this process goes, but my understanding is once I do have a court declared judgment, I could then sell that judgment for pennies on the dollar to some collections agency and they can go after the borrower for that money and get the full $18,000 plus whatever’s due. I don’t know if I’m going to sell it off or not or if I’m just going to keep it. This whole experience has brought me into another pillar for private lending. ROI is the most important thing, the return of your investment. I think another pillar should be, do not wait for the other party to do the right thing because they will rarely do it. Once we humans get backed into a corner, we’re just like any other animal. We lose all rationality. That’s what happened in this case. This particular borrower got backed in a corner, didn’t know what to do, and I feel for that borrower. At the same time, I held up my end of the bargain. They did not. In a weird way, I’m saying thank you for reading this episode talking myself into suing my friend.
I want to say it would mean a tremendous amount to me if you could leave me an honest rating and review over at iTunes or whatever platform you’re on, Spotify, iHeartRadio, SoundCloud, Stitcher or Google Podcasts. I want five-star reviews. I do read them. If there is some constructive criticism in there, I would love to know it. iTunes is still the 400-pound gorilla in the room. They’ve made it a little easier to leave a rating and review. Private Lender Podcast on iTunes. Please leave it there. That would help me out the most site. Please also connect with me on social media, Facebook, Instagram, Twitter, LinkedIn and BiggerPockets. I want to thank you for your time and consideration. I asked you to keep reaching out to me, Keith@PrivateLenderPodcast.com. I got a text from a guy wanting to drop some money in the Houston area. He doesn’t have any deals to loan on in his home state. I appreciate it. Email me. I do appreciate all the feedback I get. Besides health and happiness, most importantly self-awareness, I do wish you all safe and prosperous private lending. I’ll catch you on the next episode.