Cam Dunlap here with a knowledge bomb for you.
So, the title of this blog post is actually the exact question one of my mentor students asked me.
And I was able to concisely close his knowledge gap and level-up his ability to structure win-win deals in a way most of his competition isn’t aware of or even thinking about.
What is a Wrap Around Mortgage?
Here’s what I shared with my student…
First, a wrap-around mortgage is what you would use in a mortgage state. Whereas in a trustee state, like Georgia or Texas or California, you’re going to use an all-inclusive trust deed (AITD). I generally do business in mortgage states, most of which are judicial foreclosure states.
So, you’d consider a wrap-around mortgage if you’re buying a house from a seller who has a mortgage and:
- The balance of that mortgage is low enough to where it makes sense and you can afford to pay more than the mortgage amount…
and
- The seller is unwilling to let you take the deed subject-to the underlying mortgage. (Meaning just deed you the house and have you make the payments without paying off the loan. A lot of sellers who are highly motivated will happily do this. That’s a better arrangement, FYI, because now you have one less layer of complication. But there’s an awful lot of sellers out there who aren’t going to do that.) …
and - Your intention is to hold on to the property at least long enough to rehab it, if not as a rental.
And frankly, that’s where wrap-around mortgages really come in…
You’d create a wrap-around mortgage when you’re going to hold onto the property long term — for the next several years — and the seller is unwilling to sell it to you subject-to.
For example: The seller’s mortgage is $100,000 and you’ve agreed to pay $150,000 — you’re willing to pay more than the existing mortgage amount, and the seller is not willing to deed the property to you subject-to.
See, there’s too much equity there. $50,000. And you don’t want to come out of pocket with that.
So, your closing agent would create a wrap-around mortgage, which is effectively a 2nd mortgage, assuming there’s only 1 mortgage on the property. Now, if there’s 2, it becomes a 3rd — point is, it’s junior to any mortgage or mortgages that are already on the property.
And that wrap-around mortgage is between you and the seller. Then, on a monthly basis, you make a payment to the seller, who no longer lives in the house, and they make a payment to their lender.
So, the seller sort of stays involved. It’s a little bit of an arbitrage play for the seller, where they’re saying, “Well, I have $50 grand here in equity. This is how I can make money on that $50 grand if I don’t need it right now.”
Let’s say the seller’s underlying mortgage is at 3%, and their wraparound mortgage with you is at 4.5%… they’re going to make 4.5% on the $50 grand equity in the house, and they’re also going to make whatever the difference between your interest rate and the rate they’re paying on all the rest of the value of the house.
That’s why I say it’s a bit of an arbitrage play for a seller.
Now, think about this…
You might want to use it as a seller when you’re selling a house to a buyer who, for example, who can’t qualify at the bank. Of course, there are other ways to do that… I prefer to sell it on a lease option. But sometimes you have a savvy buyer who doesn’t want to do that — they want the deed.
Or, you’re selling to an investor who’s going to hold it as a rental… and they sure as heck want the deed because they’re going to start depreciating it at whatever value becomes their basis when they take title. There’s tax reasons for that.
So, it’s a way to leave an existing mortgage there and the seller to sell with seller financing. The seller financing “wraps around,” or like a blanket, lays over the top of the existing mortgage. And almost for sure does not violate in any way the terms of the underlying loan. Very, very rare to find a violation on the underlying loan first mortgage with a wrap-around.
Whereas subject-to, theoretically, violates the terms of almost any loan because of the due on sale clause.
Now, you could argue that if the deed transfers from the seller, who is the borrower on the underlying first mortgage, to the buyer, who’s now the borrower on the wrap-around, that triggers the due on sale clause because that underlying first was due and payable upon the sale or transfer of the deed to the buyer.
It’s a gray area. And it’s a bit like subject-to.
But, it’s a good solution if a seller is simply unwilling to hand you the keys and hope you make the payment.
Now, let’s go a little deeper…
Here’s where a problem can arise with a wrap-around mortgage: If the seller goes into default with their lender.
If there’s a wrap-around mortgage, and you’re making a payment… and the seller stops making the payment to the lender — you might get the house foreclosed right out from under you.
That would stink.
So, if you ever do a wrap-around mortgage, be cognizant of that. Good thing is, there are several ways you can protect yourself and mitigate risk. (One of which is because the seller remains responsible for their mortgage and the intent is for them to pay it.)
But let’s throw some numbers at this…
Your payment is $1,300 bucks to your seller. Their payment on the underlying mortgage is $1,000. They’re making $300.
Solution 1: Send them 2 checks — 1 for $1,000 made payable to the lender and 1 for $300 made payable to the seller. So you know that payment is going to go to the lender.
Solution 2: You could even send it directly to the lender. They’re not going to care if it’s got the seller’s name or your name on it — they just want a payment.
So, insist on making the payment to the lender yourself. Make it part of the deal. They may push back and say, “Well, how do I know you’re going to make the payment then? Maybe there’ll be a foreclosure on me.”
Then you’d say, “Fine. I’ll send you the payment made payable to the lender, and you forward it on to them.”
Solution 3: Another way to protect yourself would be to get permission from the seller to check the status of their loan 2–3 times a year, so if something does go wrong, you know about it pretty quickly. (BTW, in the case of a short sale, you will get that permission to talk to the lender directly because you need to.) So, it would be a similar arrangement with a wrap-around deal, although for different reasons.
And that’s the nitty gritty of wrap-around mortgages…
Definitely a useful tool to have in your REI toolbox.