When it comes to wrap around mortgages, most real estate investors will tell you it's a great creative financing tool. And of course, it is. What most experienced real estate investors forget to share with you is that it makes just as good of tool when it comes time to sell your investment property as well.
Like any investment, there is a time to buy and there is a time to sell. It all depends on your particular investment. As a real estate investor, you always need to be evaluating your investment portfolio. You should always know which of your investment properties is bringing in the least profit. At the same time, you should also be on the look out for a more profitable investment.
When you think you've come upon an investment opportunity that is more profitable, it's time to run the numbers to determine if you should sell one to buy the other. That means looking at the possibility from every angle. One of those angles should be selling the least profitable investment with a wrap mortgage.
A wrap mortgage can add to your portfolio profit long or short term (depending if you include a balloon payment in a few years). You, as the seller and lender, in the deal collect the spread in the interest rate as well as a higher loan payment on the equity you have in the investment. Let's say you purchased an investment property for $100,000 several years ago (with a current balance of $95,000) and can sell for $150,000 today. It's been a good investment and turns a profitable rent every month. However, it's the least profitable of your investments and there are better opportunities in today's market.
If your interest rate on the property is 4.2%, your monthly payment will be around $465 (not including insurance and taxes). When you sell with a wrap mortgage, you charge a higher interest rate. We'll use 6.5%. And you'll collect principle and interest on the $50,000 in equity that you have (selling price $150,000 minus original purchase price of $100,000). You'll also collect the 2.3% interest spread between the two mortgages.
The monthly payment you'll receive from the buyer will be around $948. A nice monthly profit of $483. Almost certainly more than your monthly profit from renting the property.
With a wrap around mortgage, one thing you want to be sure to do is get a decent down payment. You want this for two major reasons. First, so that the buyer has enough financially invested to be motivated to make the monthly payments. The wrap around you are carrying is a second mortgage to the first mortgage that you still owe. You need a large enough down payment so that the buyer isn't tempted to walk away if he or she mismanages the property or for some other unforeseen reason.
The second reason for the large down payment is to give you the cash for your down payment on the better investment property. In the end, your profits will be up substantially. You've replaced your least profitable investment with two separate income streams. You now have a more profitable rental property along with a nice monthly profit from the wrap around mortgage on the sold property.
The wrap around mortgage should definitely be in your arsenal of financing options. It will get a property sold when a buyer is willing to buy but can't get a loan in a very tight lending market. It also creates a way for you to improve your over all investment portfolio.