Another point to consider is that the bank priced its loan based upon original underwriting guidelines and being the only mortgage and that no junior financing would be added . The potential risk of negative changes in the DSCR or possibility that the borrower stripped equity away by placing a 2 nd mortgage had not been considered , and the bank was not compensated accordingly . The more debt on a property , the more likely there is for a chance of foreclosure . Although the bank may be protected in its 1 st position [ presuming that the property has not substantially declined ], when a foreclosure is triggered , there is a strong likelihood that the bank may have to alter the asset class of the property from performing to nonperforming or it may be categorized as a “ troubled asset ” or put on the “ watch list ” by regulatory bodies even if the bank is not at risk for losing money . For example , if the borrower put 35 % down on a $ 1,000,000 building and borrower $ 650,000 from the bank , the bank ’ s 65 % LTV loan may be considered conservative . However , if the borrower obtained a 2 nd mortgage for 15 % LTV , the property now is 80 % leveraged . If the borrower defaults on paying on the 2nd , he may or may not default on paying on the 1st . If the borrower defaults on both the 1 st and 2 nd , the bank ’ s loan clearly has turned nonperforming . Nonperforming loans can have a devastating effect on a bank , as they are required to set aside reserves , and defaults exacerbate this situation . The more reserves required to be set aside means the less money the bank has to lend out and generate income . Since banks lend out in multiples of their deposits , any money that is set aside [ that cannot be lent out ] has a negative multiplier effect . they do not have to use other resources to babysit a loan . The cost of these resources tax the bank ’ s bottom line . Banks are not in the business of taking over borrower ’ s properties . They do not want REO ’ s [ Real Estate Owned properties ]. It is much better for them to carefully underwrite loans in the beginning and avoid problems . If the 2 nd ends up with the property because nobody outbid the 2 nd at the foreclosure , the bank is faced with a new borrower . The bank may have to underwrite the new borrower . In fact , if the 2 nd is outbid at foreclosure , the bank is still faced with a different borrower than they originally underwrote . This new borrower may or may not qualify under the bank ’ s lending guidelines .
The 2 nd may or may not cure the 1st and start its own foreclosure . Even if the 2 nd cures the 1 st , the bank is still left with a possible foreclosing party [ the 2 nd ]. When banks make loans , they are usually looking / hoping for those loans to continue until maturity . Once a loan is made , there is less work the bank has to do . They collect the interest income and hope
Why Banks Do Not Allow Junior Liens
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