There are naysayers that don’t like wrap around mortgages because in their confusion they think they are nothing more than a second mortgage carrying a high risk for the “seller-lender”. These people are wrong. A wrap around is much more secure than a second mortgage and offers significant financial benefits to the seller-lender.
Let’s begin with a very brief explanation of a wrap around mortgage. These are also called all-inclusive mortgages or trust deeds. Unlike a second mortgage, a wrap is a new single mortgage covering the entire purchase cost of the property. The owner of the property uses seller financing to sell the property without paying off the existing first mortgage. The wrap covers both the existing first mortgage and the seller’s financing portion of the mortgage.
A Wrap Around is Superior
Here are key elements making the wrap superior to a second mortgage. A well-written wrap around mortgage contract requires the buyer to make a single monthly payment that includes both the first mortgage and the seller’s financing. The single payment is made either directly to the seller or to a third party that distributes the funds to the first mortgage holder with the balance going to the seller. What’s important here is that the seller immediately knows if a payment is missed by the buyer. With a typical second mortgage, the lender only knows when the second mortgage payment has been missed. At any time, the buyer could be racking up huge late fees by allowing the first mortgage to go unpaid. The second mortgage may or may not be paid while the buyer defaults on the first mortgage. The second mortgage doesn’t have a clue what’s going on with the first.
This is important because for the second mortgage to foreclose, they must bring the first mortgage current before receiving any funds from the foreclosure process. Because the wrap mortgage immediately knows the buyer has missed a payment, they have a couple of choices. To begin with, the wrap mortgage holder can decide to make the payments on the first mortgage to avoid piling up late and foreclosure fees. The wrap holder can then begin foreclosure while the selling price will still cover both the first and wrap mortgage.
Alternatively, if the selling price will cover late fees, the first mortgage, and the wrap mortgage, the wrap holder can allow the first mortgage to default and still foreclose from the wrap position with the ability to recover the full loan amount and pay off the first. The key being the wrap holder immediately knows when a payment has been missed.
The second important difference between a second mortgage and a wrap is the much better financials realized with a wrap mortgage. Specifically, the wrap holder (seller) is able to collect interest on other people’s money – money owed on the first mortgage.
Do the Finances
Let’s say there’s a 5.4% interest rate on the existing first mortgage. The wrap around mortgage is written at 6.5% for the entire purchase price. To keep things simple, we’ll use round numbers of a $100,000 loan for the first mortgage with 20 years remaining and $135,000 for the wrap selling price with a $5,000 down payment. Here’s what the monthly payment looks like for a 20 year wrap around mortgage.
$969.25 paid to the seller as the wrap holder
– $561.53 paid to first mortgage
$407.72 pocketed by the wrap holder each month
Here’s how the numbers work if the seller finances with a second mortgage. He would only collect the 6.5% interest on the $30,000 loan ($135,000 sales price – $100,000 first – $5,000 down payment).
$223.67 paid to seller as the second mortgage holder.
The wrap pays the seller $184.05 more each and every month ($407.72 – $223.67). Or an additional $44,172 over the 20 year mortgage.
The next time someone tries to convince you that a wrap around mortgage is just another name for a second mortgage, you’ll know that both risk-wise and financially the wrap around is far superior.
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Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 10 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.