What Is A Wrap Around Mortgage?
Creative real estate strategies are often used to sell a home when other traditional tactics fail.
One creative option is called a wrap around mortgage. A wrap around mortgage occurs when the original seller or investor agrees to carry the note on a property that already has financing in place. However, unlike a mortgage assignment, in which the new owner just pays the loan already in place, a wrap generates a new contract between the note holder and the house buyer. The buyer will pay the seller or investor the monthly agreed on amount in the new note, and the seller or investor will be responsible for paying the underlying lien to the bank. Often the payment amount on a wrap around mortgage is more than the actual loan is worth, which allows the seller/investor to make a profit.
This method does not excuse the original note holder from the terms of the contract with the bank, but it does allow them to move on with their life, and not have to worry about the original mortgage payment coming out of their pocket every month.
However, should the buyer miss a payment, or be late to the seller/investor, then the seller/investor is still obligated for the payment of the underlying mortgage. Any failure to insure the underlying payment is paid in a timely manner will affect the credit score of the original owner, not that of the buyer.
There are several legal tactics used for wrapping an existing mortgage. Always consult a lawyer before attempting these types of real estate transactions.
We personally use attorneys who have closed 1000’s of these types of contracts successfully. Refer to our legal corner if you’d like more information.
The scenario below is for example only, and will change depending on the state in which you are selling the home.
Sealing the Deal with the Contract
The contract is always the first piece of the puzzle. You can typically find your state contract online and then accompany it with one of three addendums:
1) Seller financing addendum – this is used whenever you are wrapping a note or offering financing on a free and clear property.
2) Assumption addendum – this is used whenever you are assuming an underlying lien, even in a subject-to transaction. Many attorney’s call the subject-to part of the deal, a “silent assumption” and that is why they still use this form despite it not being a “traditional assumption” through the bank.
3) Attorney drafted addendum – this is what we use and this addendum is customized to the type of transaction you do in your particular state.
Once signed, this contract gives you equitable interest in the property so that you can do your due diligence or market for an end buyer depending on your exit strategy. Depending on the type of transaction, the deed will either transfer at closing (which is the way we do our deals), or it will transfer once the contract has been fulfilled (like in a contract for deed scenario).
Getting it to Escrow
Once a contract is fully signed and executed, an escrow agent will assist you with the deal once you’ve sent it in to the title company or attorney’s office.
Depending on your exit strategy (if you’re the end buyer or if you’re marketing for one), this is when you’ll begin the next steps to move forward with closing or beginning the marketing.
Once all parties are in place for the transaction to close, the title company or attorney’s office will proceed with any contractual obligations that need to be met prior to closing. As long as banks are not involved, this process can move fairly fast with title being the one thing that will tend to hold up closing.
At closing, all parties will sign the necessary disclosures and legal documents to protect each party’s interest. The seller/investor will each have the property paperwork which will give them the power to foreclose on the end buyer if the buyer defaults on payments. Of course, you’ll still have to follow the state’s guidelines on foreclosure unless you’re working with an attorney who has structured your transaction in a way that allows you to bypass some of those lengthy waiting periods. For more information on that advanced strategy, please visit our legal corner.
The buyer will also be provided with legal documentation regarding their rights of ownership and this varies greatly depending on the type of transaction you did and the state in which you are closing.
Sam & Billy Take the Stage: Three Ways To Structure A Wrap Around Mortgage
Here is an example of how this transaction might work where there is no investor in the middle and the wrap around mortgage is simply going to take place between the original seller and wanna-be homebuyer.
Let’s suppose that Sam Seller is selling his house for $100,000. Billy Buyer has $20,000 to put down, but since his credit is bruised, it’s hard for him to get a regular mortgage. Sam’s existing mortgage is just under $60,000. He doesn’t need all of the $40,000 in cash, so he agrees to carry a note in the amount of $80,000.
For those of you keeping score at home with a calculator, let’s get precise on these numbers. Sam’s existing mortgage of $59,426.02 has a 7% interest rate and monthly payment of $498.98 per month with 17 years left on it. Here are three different ways to structure this deal.
1. Create one contract for a wrap around mortgage in the amount of $80,000.
The early negotiations had suggested a payment of $750 per month at 7.5% on the $80,000. The problem is that this note would pay out in less than 12 years, leaving a balance on the underlying mortgage. That would cause problems for every one involved.
Instead, Sam and Billy settled on a payment of $694.97 at 7.5% for 17 years, which matches the length of the mortgage. Every month when Billy makes his payment Sam will pocket the difference: $694.97 – $498.98 = $195.99.
A quick side note is that in this same example, Sam could have also amortized Billy’s loan a full 30 years with a higher interest rate. There are many ways to structure these deals depending on all the variables of the deal.
2. Create two separate contracts
Another way to structure the deal is to create two separate contracts. The first contract would be an assumption of sorts – consult with your attorney on what addendum he wants you to use for this type of subject-to deal. The bottom line is that this first contract would match the terms of the existing mortgage. This is called a “silent assumption,” an “assignment,” or a “subject to.” It would match the mortgage’s balance, interest rate, payment amount and length of term.
The second contract would be a seller financing addendum that detailed the difference between the $80,000 and the mortgage balance. For purposes of following this example, the difference equals $20,573.98. If we took that amount and amortized it over 17 years (to match the first lien’s term) at 7.5%, the payment would be $178.73 per month. Billy’s total payment would be $498.98 for the first lien + $178.73 for the second lien which equals a total monthly payment of $677.71.
This situation is advantageous for Billy because he gets to assume the same interest rate on the first mortgage which saves him money compared to example #1.
3. Different terms on second contract
Let’s say that Sam only wants to collect payments for the next 5 years. So, on that second contract, he asks Billy for shorter terms.
For that $20,573.98 at 7.5% for 60 payments, the payment amount would be $412.26. If Billy can afford this payment, it would be great for him because in five years, his payment would go down to $498.98.
However, Billy doesn’t think he can afford the higher payment right now. As a matter of fact, he would like as low a payment as possible. Sam says, OK, we’ll do a 30-year amortization, but you will have to pay off the whole balance in five years. Billy thinks his credit will be better in five years and he’ll be able to refinance, so he says OK. The new payment with a 30 year amortization would be $143.86, but the balance would still be $19,466.57 in five years when it is time for him to pay off that loan or refinance it. It’s a win for Billy right now because he gets a lower payment, but he also has the risk of having to come up with a large payoff in five years.
If you’d like to learn more about building passive income by buying and selling real estate for a profit with no money down using strategies like subject-to and wrap around mortgages, then check out our very affordable REI Rockstars Back Stage Access Coaching Series for both new and seasoned investors!
If you prefer not to stay in the middle of transactions and simply want to sell your contracts for a quick fee, then you’ll want to learn more about how to do mortgage assignments and wholesaling, and we teach that in our coaching series as well! For under $100/mth, you’ll learn Four (4) No Money Down Real Estate Investing Strategies so that you can better evaluate the deals you come across in order to make maximum profit!