Summary:

A daisy-chain loan brokerage transaction works as follows:

Broker-A refers to the developer and gets information about a real estate loan request. 

Broker-A then contacts Broker-B.

Broker-B contacts Broker-C.

Broker-C has a relationship with Broker-D, who works with private investors to fund real estate loan transactions.

After reviewing the loan transaction, Broker-D quotes a second lien position with 12% interest-only monthly payments and a 2-point origination fee for a 24-month loan.

But each broker wants to get paid. Each question is worth 2 points. In mortgage brokerage, a 'point' is a fee equal to 1% of the loan amount. So, in this case, each broker demands a fee equal to 2% of the loan amount. This means that for a $500,000 loan, each broker would demand $10,000, which can significantly increase the cost of the loan.

Article:

Here is a classic real-life example:

A developer had almost completed his mini-storage construction project but was about $500,000 short of achieving it. The developer had a $4,000,000 first-lien construction loan that was nearly fully funded. Upon completion, the developer planned to rent units to the public until rent stabilization, or approximately 95% occupancy. Then, the developer planned to refinance with a long-term permanent loan with an institutional lender. However, due to the daisy-chain issue, the developer faced unexpected financial hurdles.

The loan terms quote appears reasonable given the risk/reward for making a $500,000 loan subordinate or junior to a $4,000,000 first lien. Then comes the emotional rallying cry from each Daisy-Chain broker for a piece of the action, each demanding 2 points for their fee.  The end resulted in presenting an offer to the borrower to pay 8 points plus appraisal and closing costs. This excessive demand from the participating Daisy Chain brokers led the borrower to reject the offer, which could delay the project and incur additional fees. Each broker earned zero income, highlighting the negative consequences of the Daisy-Chain issue and the need for caution and awareness of potential pitfalls.

There is a dramatic discrepancy in pricing when Daisy-Chain mortgage brokers expect a significant piece of the action.  In many cases, each broker may have spent less than 1 hour only to expect a big lottery payoff. This should be a cautionary tale, informing you of potential pitfalls. However, by being well-informed about the Daisy-Chain issue, you can avoid such traps and be better prepared for your transactions, feeling knowledgeable and in control.

It's important to distinguish between a mortgage broker who receives a relatively small finder's fee for passing a lead to another broker and a mortgage broker who works with private party investors. The latter has the task of procuring loan transactions, completing processing, underwriting, funding, and closing, and managing private party investors, including the servicing process for the life of the outstanding loan until the payoff. This type of broker takes on more responsibilities and risks but also has the potential to earn higher fees.

Many prominent mortgage brokers who fund loans with private party beneficiaries indicated they solved the Daisy-Chain issue by capping all the mortgage brokers' aggregate fees, not exceeding their origination fee.

Understanding that state-by-state lending laws and securities regulations will differ regarding what is acceptable for a broker's compensation or a finder's fee can be financially beneficial. This knowledge will keep you informed and prepared for potential legal implications, giving you a sense of security and confidence in your transactions and making you feel well-prepared and knowledgeable. It can also lead to significant financial benefits, ensuring you are not overpaying for broker fees.

As with all loan transactions, it's important to remember that interest rates, terms, and fees are negotiable between the parties. This flexibility empowers you to tailor the deal to your needs and circumstances, ensuring you control the process and feel confident in your decisions. You have the power to negotiate terms that work best for you, but the borrower must accept them. The borrower must perceive they are getting the best deal possible, given their property and the inherent risks, making you feel empowered and in control of your transactions.