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When Wraparound Financing Is Used By Investors
While being a little risky, seller financing makes it easier for a seller to let go of a property that can be a tough sell.
It eliminates the need for a buyer to go though the credit analysis process that lenders would put him through. Helps him save on loan costs and makes closing a breeze.
And if the seller is smart, he would be able to find ways to squeeze more cash out of the transaction.
Wraparound financing is a classic way to do just that.
The basics of the wrap is for the seller to continue paying for the existing mortgage and collecting mortgage payments from the buyer at a premium.
The spread will then be an additional cash income for the seller.
For example, let’s say a seller has a $100,000 house with 90% loan. It’s a 30 year mortgage at 5% working out to $500 installment a month. He then sells the property to a buyer at $110,000 with 10% down payment and the balance of $99,000 at a financing rate of 6% for 30 years. This works out to a monthly payment of approximately $600.
By retaining the original mortgage for the house and collecting payment from the buyer to pay for the loan, the seller effectively banks in an additional $100 ($600-$500) a month of cash flow for the next 30 years.
Not too shabby!
The more expensive owner-carry loan has wrapped around the existing mortgage.
To maximize the profits and cash flow of such a deal, it is best that 2 conditions are met.
First being that the seller is on a low mortgage rate and able to secure a buyer willing to pay for a higher financing interest rate.
Secondly, the seller bought a property below valuation and sold it at valuation or higher.
However, the presence of either condition will still make the deal worthwhile for the seller.
The danger with such deals, as always, is whether the buyer can be trusted to continue making payments diligently.
An individual will typically fear a financial institution more than an individual as the former will mean business and wouldn’t bat an eyelid to take customers to court. This makes them more unlikely to default against a bank than an individual.
This is why in a wrap transaction, the seller would demand a buyer to provide a promissory note for the complete purchase price secured by a deed of trust or the mortgage itself.
At closing, the buyer will obtain the title while the seller will have a second wraparound mortgage with junior lien after the first mortgage.
If circumstances permits, the possibility of subordination can be considered.
At this point, the wraparound mortgage will typically be similar to a regular mortgage. Except that it will also contain the terms of the senior mortgage.
Unlike assuming a mortgage whereby the new owner takes over the existing loan obligations, a wraparound requires the seller to continue making payments towards the mortgage.
The seller collects payments from the buyer, and then pays off the debt obligations under his own name as the debt is technically still his burden.
When a deed of trust is the instrument of choice rather than a mortgage, it is often referred to as an all-inclusive trust deed. While technically different, they have the same concept.
More ways to profit
As you can see using a wraparound mortgage is like buying money from the bank and selling it to a buyer.
The best part is that there is minimal hassle as it does not involve a new loan application with a lender.
This means that when a seller is faced with a buyer who proposes using a second mortgage as part of package to finance the purchase, swaying him towards a wrap can be much more profitable.
The buyer will not incur extra expenses. Yet the seller will get to book in more profits.
At times, when a seller is not willing to give up the deed as a buyer is only willing to agree similar terms of the existing mortgage, a mirror wraparound can be used.
This can happen when the owner has little to no equity but desperate to let go of the property.
A mirror wraparound would mean that the wrap would essentially contain the same terms as the existing mortgage.
Finally, when in doubt do consult the advice of a real estate attorney familiar with local real estate laws and practices.
Wraparound financing are not for newbies and is the playground of more experienced investors.