What is a Wrap-around-mortgage?
A creative alternative to leasing may be selling with owner financing, using an instrument called a wrap-around mortgage, or “wrap”.
A wrap is simply a new mortgage that is created that “wraps around” the old mortgage.
Example:
- Home value: $200,000
- Existing loan amount: $180,000
- Existing interest rate: 7.25%, fixed
- Purchase price to investor: $110,000
The owner can sell the home to a new buyer with the following terms:
- Sales price: $205,000
- Down Payment: $10,000
- New “wrap” mortgage amount: $195,000 (the balance on the new loan)
- New interest rate: 8.5%
In this example, the homeowner pockets the $10,000 down payment (which helps cover closing costs), and collects the monthly mortgage payment of $1,500 (8.5% on the $195,000 loan), which is used to pay the existing mortgage payment of $1,225 (7.25% on the $180,000 loan) resulting in $275/month in positive cash flow. Note: every deal is different – this is a pretty good one.
Of course the seller must also make provisions for taxes and insurance by creating a new escrow account to account for these expenses. Or they can pass the existing escrow to the end buyer. Or they can simply rely on the end buyer to cover these expenses without an escrow account. Beyond that, several other minor details must be worked out, and it is important that the transaction be structured legally and properly.
The disadvantage to selling with a wrap is that it is always possible that the end buyer will stop making payments, in which case the original seller must foreclose on the property, re-establish possession, make any needed repairs, and resell the property again. Obviously, these activities could incur significant expense. By some estimates, this occurs in 70% of these types of transactions, however, this depends greatly on many factors, and can be structured in ways that make the success rate higher.
Hippie Hollow Homes has extensive experience selling homes with wraps and buying homes with various forms of owner financing. One of our strategies is to list a home for a client and simultaneously offer the home for sale with owner financing (which may attract more buyers faster). If you are interested in this strategy, and others listed on the website, give us a call – we can help!
Questions About Wrap-Around Mortgage
Can any home be sold with a wrap?
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Yes, pretty much. Even if there are multiple liens, a new wrapped mortgage can be created and the home can be sold. In some cases, a seller can even create a wrap-around mortgage in which the monthly payment is for LESS THAN the underlying mortgage payments – resulting in negative cash flow. Why? Because it may be the only way to get the home sold. Of course in these situations, there may be better options – call us.
How long does the wrap last and what happens when the buyer sells or refinances?
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Most sellers will structure this so that the buyer is required to refinance the wrapped loan after 3-5 years or sell the home. If the buyer fails to do so, the seller can structure penalties in the contract such as raising the interest rate, and monthly payment, or getting the home back. At the time that the home is refinanced (or sold) the underlying loan is paid off and the remaining balance (a profit) is paid to the seller. In the example given above, the seller would get $15,000 when the home is refinanced. Investors call this “the back end profit”.
Can the lender call the loan?
Technically yes, but practically no. Whenever a home is sold, the underlying lender technically has the right to “call the loan due”. Almost all notes have a “due on sales” clause in them that give lenders this right. That being said, we have never seen a case in which a lender actually calls a loan in which the loan payments are being made in a timely manner. Logically speaking – it would not make sense for them to do so. Additionally, it would take the lender some effort and research in order to even know that a sale took place. Finally, there are some strategies to further disguise the sale, however, it is debatable whether these strategies are necessary.
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