This year's Cash Flow Expo introduced me to many knowledgeable investors in the note space--one them being DJ Olojo. His lecture titled "The Good, the Bad, and the Ugly of Second Position Notes: Risky on Paper, Powerful in Practice" included a case study on one of his successful note purchases in which a "small" $2,565 note with a $14,442 UPB on a $69,000 property wound up costing him $19,981.29. As a novice looking to start in this space, the true "cost" of investment had me thinking: 1) Which fees play a major role in making "small" junior liens not so small and, if so, are there ways to eliminate this cost? 2) Is there a way to factor in outsized costs when calculating return assumptions prior to bidding? 3) Should reports of some investors earning 3-10 times their original investment with junior notes be viewed as outliers?

That hesitation is common, but experienced investors often prefer 2nd liens (Junior Liens) precisely because the risk profile is misunderstood. While Second Liens are subordinate in priority, they offer “asymmetrical return opportunities” where the potential profits often outweigh the risks when bought correctly. Here is why you would buy a Second Lien instead of a First, and how the risks compare: 🟢 The “Senior Shield” (Risk Mitigation) The biggest fear with Second Liens is being wiped out by a foreclosure. However, the First Lien holder actually acts as your first line of defense. *️⃣ Taxes & Insurance: In 80%+ of residential first mortgages, the Senior Lender escrows for property taxes and insurance. This means the First Lien holder is paying the taxes to protect their interest, which inadvertently protects your interest as the Second Lien holder from being wiped out by a tax sale. *️⃣ The Canary in the Coal Mine: If you buy a non-performing Second Lien behind a Performing First Lien, you have massive security. If the borrower is paying their First mortgage every month, it signals they intend to stay in the home. They are unlikely to let the house go to foreclosure, meaning your Second Lien is safe from being wiped out. 🟢 Better Collateral, Lower Price Second Liens allow you to control better real estate for less money. *️⃣ Higher Property Value: First Liens on the secondary market are often secured by lower-value assets (averaging ~$96,000 in a recent portfolio we sold). Second Liens are often secured by higher-value homes (averaging ~$347,000). *️⃣ Borrower Quality: Borrowers who qualified for two mortgages generally had better credit and higher income profiles initially. They tend to have more “pride of ownership” and take better care of the property than borrowers with low-value First Liens. *️⃣ Diversification: Because Second Liens trade at deeper discounts (often 60% of UPB or less), you can buy a diversified portfolio Second Liens for the price of one or two First Liens. This spreads your risk; if one deal goes bad, the others cover it.