A wrap around mortgage is a mortgage created for a new buyer that is used to secure the new debt and includes the balance due under any existing mortgages. For example, an owner has a mortgage balance of $120,000 and sells his house to the new buyer, using a wrap around mortgage for $160,000. Instead of applying for a new loan, the buyer makes payments to the owner. The owner, in turn, continues to make payments on his original mortgage. The wrap mortgage is junior to the underlying mortgage or mortgages.
The wrap around mortgage can be for a larger amount than the original mortgage and the interest rate can also be higher than the underlying interest rate. It’s a powerful way to leverage a low-interest loan to create a monthly cash flow.
Wrap around mortgages have been around much longer than people realize. In fact, the wrap around mortgage was standard operating procedure in banking for decades. The difference between then and now is that banks used to wrap the mortgages and make the money on the spread. In our scenario, you can create a wrap and make that money.
What Is A Wrap Around Mortgage? — A Brief History
Back in the early days of lending, when a new buyer would apply for a home loan, his bank would create a new mortgage and note for the full price of the property. But, instead of paying off any underlying mortgages on the property, the bank would continue to make payments to the original lenders. They basically wrapped the old mortgage and made the spread.
How could they do this? Simple. Most mortgages, up until the 1980s were non-qualifying, assumable loans. In fact, as long as the payments were being made, no one seemed to care who was making them. Not surprisingly, this created some problems if the new payee defaulted. The last of the non-qualifying assumable loans died out in 1989 and the due-on-sale clause became standard. Don’t forget, wraps were standard practice between banks. You may have noticed that banks have one set of rules for themselves and another set for everyone else.
What Is A Wrap Around Mortgage? – Present Day
Today’s wrap around mortgages work much in the same way except that you, as the seller, can wrap the mortgage. This works particularly well if you have a low interest loan and can create a spread at a higher interest rate that is still affordable for your buyer. It does not work well on a high interest rate loan. At that point, you may have to keep the interest rate the same and the only spread you will make will be on the difference in the mortgage balances.
If you have an adjustable rate mortgage, you need to make sure that fact is built into paperwork and have clauses that allow you to adjust the buyer’s interest rate proportionately. This can be a very precarious position for a buyer. Your best bet may be to create a balloon mortgage that comes due before the interest rate ratchets up beyond yours and your buyer’s abilities to pay. As a general rule, wrapping an adjustable rate mortgage is not a good idea.
Another caveat is the due-on-sale clause. The due-on-sale clause gives a lender the right to call a loan due if the property is sold. It does not mean that the loan will necessarily be called by the lender, and in fact, hardly ever is. But it is a risk you will need to consider.
You can work around the due-on-sale clause by using a Contract or Agreement for Deed. In this scenario, the deed doesn’t transfer to the new buyer until all of the payments are made. The property title doesn’t transfer and a closing doesn’t take place.
Just to be clear, when you wrap a mortgage, the buyer does NOT assume the loan. The loan stays in your name and you continue making the payments. You are still responsible for the loan and it still shows up on your credit report. On the plus side, because the buyer makes his payment to you, you can be sure the payments are made on time.
What Is A Wrap Around Mortgage? The Answer To Investors’ Problems!
In today’s environment of tight lending practices, knowing how to create a wrap around mortgage can open up your choice of buyers, getting your property sold more quickly and, because you are offering financing, at full price. In some markets, owner financing can create a premium price for your property and you may be able to charge a bit above market value.
You are the person who determines if someone qualifies or doesn’t, you can set the interest rate, you can name the down payment you want. Wrap around mortgages put you in control of the deal, which is exactly where you, as a clever investor, want to be.
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