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Use a Wrap Around Mortgage To Purchase With Seller Funds A wrap around mortgage more commonly referred to as a "wrap", is a form of secondary financing used for the purchase of real estate. A wrap-around mortgage is also commonly called an All Inclusive Trust Deed (AITD). All Inclusive Trust Deed (AITD) is a new deed of trust which includes the balance due for the existing Mortgage note plus new funds advanced to the Seller. With a wrap around mortgage, the seller gives the buyer a junior mortgage which wraps around any existing first mortgage already secured by the real estate. Under a wrap agreement a seller accepts a secured promissory note, an AITD from the buyer for the amount due on the underlying first mortgage plus an amount up to the remaining purchase price. The new buyer makes monthly payments to the seller, who is then responsible for making the payments to the underlying mortgagees. Should the new buyer stop making those payments, the seller has the right to foreclosure to recapture the subject property back. Due on Sale As title is actually transferred from seller to buyer. The biggest danger you could encounter with a wrap around mortgage is to the seller. Most every mortgage today has a-" due on sale" clause. This means that if the real estate is sold. The entire mortgage balance is due and payable upon transfer of title. If the seller cannot pay that amount or borrow it and pay it, the lender could foreclose on the real estate. There is very small chance that the due on sale clause will actually be enforced by the mortgage or a foreclosure will even take place however sellers and the buyer must both be aware of the risks. This has never happened to me in all my years of real estate investing so the chances are slim at best. Borrower Default The seller has also taken on all of the risk of a traditional lender in a wrap around mortgage. If the borrower doesn't pay his mortgage payments then the seller bears all the costs associated with enforcing the loan and foreclosing. In addition if the borrower doesn't pay as agreed then the seller is at risk of being unable to pay his mortgage and could face foreclosure himself. This can occur even though the borrower is causing the problem by not paying. The wrap around is a junior mortgage and as such is in a second position for enforcement. If the seller cannot pay the first mortgage even when it is the buyers fault the original mortgage lender has the first claim and can foreclose on the original owner and borrower.
As an example, if a buyer consistently makes monthly payments however the seller is not paying the first mortgage, then the original mortgage lender can foreclose on the home. When considering a wrap around mortgage both seller and buyer must consider the risk in entering into a purchase and sale agreement. Example of a wrap-around mortgage secured by an AlTD The seller who has the original mortgage sells his home with the existing first mortgage in place and a second mortgage which he "carries back" from his buyer. The mortgage he takes from the buyer is for the amount of the first mortgage plus a negotiated amount less than or up to the full sales price minus any down payment and closing costs. The monthly payments are made by the buyer to the seller who then continues to pay the first mortgage with the proceeds from the payments. When the buyer either sells or refinances the property all mortgages are paid off in full with the seller entitled to the difference in the payoff of the wrap and any underlying loan payoffs. For demonstration purposes lets assume that Mike has an existing "assumable" loan balance of $100,000 and Janise Buyer can afford a down payment of $25,000. The property is being sold for $200,000 leaving Mike Seller with $75,000 in equity. One option is to have Janise to assume the old loan and have Mike create a second Trust Deed for his $75,000 equity. A safer option for Mike might be to create an AITD or "wrap around" mortgage around the existing $100,000 old loan in the amount of $175,000. For the example: $175,000 "wrap" note at 10% interest fully amortized over 30 years which is due and payable in 5 years from closing. An AITD allows Mike to hold a note in 1st position instead of 2nd position. However, with an AITD Mike will be responsible for the collection of the payments from the buyer as well as making the payments on the old loan. The Note Structure Selling price: $200,000 Positive Cash Flow New monthy payment of: $1,525.75 5 Years Later... Payers make balloon payment of: $169,504.99 TOTAL MONEY EARNED ON SALE OF PROPERTY = $72,519.40 ANNUAL PROFIT OF $9503.88 / $75,000 EQUITY = 13% ANNUAL RETURN ON EQUITY It Even gets better…!!! A "Wrap" allows Mike Seller to spread the capital gains tax on his $50,000 equity (additional profit excluding down payment) over a period of time (the term of the note), that would otherwise be considered taxable in the year of the sale. (consult with your professional tax advisor) Return from Wrap Around Mortgage to HOME |
