What Is A Wrap Around Mortgage?
Creative real estate strategies are often used to sell a home when other traditional tactics fail.
Wrap Around Mortgage
One creative option is called a wrap around mortgage. A wrap around mortgage occurs when the original seller 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 the monthly agreed on amount, which they pay to the bank. Often the payment amount is more than the actual loan is worth, which allows the seller a profit.
The Seller Is Not Off The Hook
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 pay the mortgage payment.
However, should the buyer miss a payment or be late to the seller, the seller is still obligated for the payment of the underlying mortgage. The seller’s failure to insure the underlying payment in a timely manner will affect his credit score, not that of the buyer.
There are a several legal tactics used for wrapping an existing mortgage. Always consult a lawyer before attempting these types of real estate transactions.
We always use our experienced lawyer who has closed thousands of these types of contracts successfully.
This scenario is for example only, and will change depending on the state in which you are selling the home.
Sealing the Deal with the Contract
Many investors use a Real Estate Contract. An REC or a Memorandum of REC is recorded giving equitable title to the buyer, but no deed is recorded until the contract is paid in full. The seller remains as the titleholder.
Getting it to Escrow
Usually an escrow agent services the contract, but in other states it may be an “account servicing” or even “contract collections.”
Smart Investors Use A Title Company
Often a title company will close the transaction. The title company will create two deeds, one for each side of the transaction. A Warranty Deed is given to the buyer when the contract is paid off. A Special Warranty Deed is released to the seller if the buyer defaults. This is how the seller gets the property back.
Sam & Billy Take the Stage
Here is an example of how this transaction might work.
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 contract in the amount of $80,000. (In most cases you will have other fees to consider as well, so be sure to keep that in mind.)
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 at 7% at $498.98 per month has 17 years left on it. Here are three different ways to structure this deal.
1. Create one contract 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.
Sam and Billy, with the broker’s help, settle 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 about 694.97 – 498.98 = 195.99.
2. Create two separate contracts
Another way to structure the deal is to create two separate contracts. The one in first position would exactly match the terms of the mortgage. This is called a “dollar for dollar” wrap. It would match the mortgage’s balance, interest rate, and payment amount. The second contract would be the difference between the $80,000 and the mortgage balance.
This second contract, if it amortized at the same rate as the mortgage, would have a balance of $20,573.98. At 7.5% for 17 years, the payment would be $178.73 per month. Billy’s total payment would be 498.98 + 178.73 = 677.71.
This situation is advantageous for Billy because he get’s the same interest rate as on the mortgage for most of his payment.
3. Different terms on second contract
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 agrees. The payment would be $143.86, but the balance would still be $19,466.57 in five years. Billy gets a lower payment, but 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! Get to know others in your local real estate market. It is helpful to get the advice of investors who have more experience. A couple of acquaintances that know real estate investment can be handy. You can easily find like-minded people by finding a real estate investing group online to join. Join a few forums and make an effort to meet some of the users.
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