More Ideas To Help You Succeed Using A Wrap Around Mortgage
Table Of Contents
- Ideas Gift Wrapped For You
- Preliminary Ideas
- Documentation
- Contract For Deed
- More Due Diligence
- Nontraditional Uses Of A Wrap Around Mortgage
- Something For A Flipper
- How About A Private Lender?
- Wrap Around Mortgages Can Work For Commercial Property (Business Notes Are Related)
- Examples of Commercial Seller Financing
- Are You Selling Only Commercial Property Or A Business Also?
- Have You Considered Selling A Note?
- Frequently Asked Questions
- More Resources For You
Ideas Gift Wrapped For You
To buy or sell property, what would a real estate investor do to make money that some of you would not be familiar with? What could a motivated home seller do in less than ideal circumstances, with proper guidance?
Wrap around mortgages offer all sorts of possibilities.
This article is intended to be more than introductory. So my article Should You Use A Wrap Around Mortgage? would be a good place to start.
Preliminary Ideas
The suggestions offered throughout these articles move in the direction of creating quality promissory notes that experienced note buyers prefer to purchase. This relies on using proper due diligence that will also benefit property sellers whether they sell the note or not.
Your equity in a wrap around mortgage month by month is equal to the amount that is owed to you on the wrap, minus the amount that you owe on the underlying loans. This changes monthly because of the amounts going toward principal and interest.
In Should You Use A Wrap Around Mortgage? I identified some of the concerns you could have by using a wrap around mortgage. Of course the mortgages need to be paid. So issues could come up that delay payment or lead to default, and deferred maintenance is another possible problem. Such problems can be anticipated and handled in the contract
Documentation
For those of you who don’t like long paragraphs here is one below that you should find helpful. This is an actual example of the Wrap Provisions used in the sale of residential property, taken from the recorded Note. I have made some of the specific references generic for privacy.
You can see how an attorney might protect the interests of both buyer and seller based on the deal they have agreed upon. This should also help you get a better feel for the process.
Wrap Provisions
This is a Wrap Mortgage. Any amounts due Mortgagee under this agreement are subject to the prior right of the First Mortgagee, up to the amount then due First Mortgagee. The Mortgagee represents that she is the owner in fee simple absolute of the above described premises and has title to same, free and clear of all liens and encumbrances, except the lien of a non-assignable First Mortgage given by Mortgagee to XYZ Mortgage Corporation and which Mortgage is recorded in the Generic County Clerk’s Office in Liber 12345 of Mortgages at Page 6789. The Mortgagee herein warrants and represents to the Mortgagor herein that she shall promptly pay the First Mortgage as the same becomes due and payable. The Mortgagee herein makes no representation concerning the position of said XYZ Mortgage Corporation, its successors or assigns, with respect to this Wrap Mortgage. In the event First Mortgagee shall determine this conveyance to be a sale or transfer within the meaning of the Mortgage and call the Mortgage in or raise the interest rates, then in such event, the Mortgagee herein has the option to accelerate the amount due under this Wrap Mortgage and call the same immediately due and owing. In the event of any default of the Mortgagee herein, the Mortgagor herein may, amongst others, pay to First Mortgagee any sums due it and deduct same from any amounts due Mortgagee herein. Upon Mortgagor’s refinance of premises after Wrap Mortgage’s maturity, Mortgagee herein agrees to discount the amount due under this instrument by $11,500.00 making the amount Mortgagee herein agrees to accept in full satisfaction of this Wrap Mortgage approximately $58,000.00, which sum is to be applied first to satisfaction of any sums due under the First Mortgage.
As you reflect on this document can you picture the agreement that was made between the buyer and the seller that lead to this wording? Did you get the impression that there was a balloon payment that led to the Wrap Mortgage’s maturity? If you use your imagination you can visualize how such a document could be worded to match your own wrap mortgage terms.
Contract For Deed
A contract for deed is a way of selling property while the seller keeps legal title temporarily. After the buyer has paid an agreed upon amount of money, the seller gives the buyer a fee simple deed to the property. This type of agreement can be used when the buyer has a small down payment or a low credit score. It is also a way to sell property without paying off an existing mortgage.
A contract for deed may or may not be a wraparound mortgage depending on whether the seller still has a mortgage or mortgages on the property.
A contract for deed could be used to sell on wrap rather than rent out the property. Maybe you have tired of your single family rentals. You would prefer to let go of maintenance, management, insurance, handling rent increases and vacancy issues. Selling on a contract for deed would allow you to convert your property into a self-liquidating cash flow.
Let’s expand on the last idea. If you have a group of rentals with mortgages expiring over the next 20 years, you could sell them on wrap around mortgages expiring in 30 years. Ideally you will receive more interest than the mortgages you are paying on. As your underlying mortgages are paid off, your cash flow will increase from the mortgages being paid to you. This could be used as a long term plan to invest in real estate and gradually liquidate.
More Due Diligence
As a seller offering a wrap around mortgage, there is some value in imitating a banker's approach. They view owner occupants as a lower risk than rental property. So make sure that the buyer of your property doesn’t rent it out, when you expect the buyer to live there.
You can put a clause in the promissory note that prevents usage as rental property. Otherwise you lose control of who is living in the house. As you should be using proper due diligence to evaluate your potential property buyer, you would not have this opportunity if they rent the property. If you had to foreclose on the property buyer, dealing with the tenants would add to the time and cost involved.
While a property seller doesn’t want to be in a position to need to foreclose, if you need to, a deed in lieu of foreclosure could be a better option. So in your due diligence make sure that the prospective buyers do not have any judgements that could attach to the property.
You should also consider adding a clause to the note that requires proper maintenance. Here is an example:
“Maintenance of Mortgaged Property. At all times maintain, preserve, and keep the Mortgaged Property in good repair and condition, and from time to time, to make all necessary and proper repairs, replacements, and renewals, and not to commit or permit any waste on or of the Mortgaged Property, and to do anything to the Mortgaged Property that may impair its value.”
This example is taken from Law Insider where you can find related examples.
Nontraditional Uses Of A Wrap Around Mortgage
The typical advice is make sure that the payments on the wrap around mortgage are greater than the payments on the underlying mortgage. This is so the seller makes a monthly profit in addition to enough money to make the underlying payments. Why would the seller take less monthly? Here are some ideas:
For starters be aware that some individuals and businesses are willing to buy investment property that initially produces negative cash flow. That type of mindset can be part of the answer.
A seller of a property could simply be highly motivated, and have a buyer ready to purchase who needs a wrap around mortgage to close quickly. Perhaps the property also needs improvements which reduce the number of prospective buyers. The buyer that’s ready to purchase could be skilled in making the property improvements.
The seller may prefer to keep the underlying mortgage open in their credit history a while longer. Of course they need another source besides the wrap around mortgage to pay the underlying mortgage payments. Some other aspects of the deal would likely need to work for the buyer and seller.
One such aspect could be a sales price higher than current market value. Buyer and seller may have confidence that the value will appreciate. So the seller gets a higher sales price and the buyer gets a more affordable way to make the purchase.
A wrap around mortgage with negative cash flow could be structured with a balloon payment. Similar to the points made above, the details would need to give the seller sufficient returns to make the initial negative(s)acceptable.
Stepped payments provide another alternative. The promissory note could be written to start with lower payments that increase in the future. For helpful input on this concept take a look at What’s Better, A Balloon Note Or Stepped Payments?
A large down payment could make lower payments work initially. This may fit the timing of current needs along with upcoming resources.
There are some favorable tax aspects of a wrap around mortgage that I covered in the section “Tax Considerations” at Should You Use A Wrap Around Mortgage? So this adds to the methods above.
I discussed a Contract For Deed above and mentioned that a contract for deed may or may not be a wrap around mortgage depending on whether the seller still has a mortgage or mortgages on the property.
Depending on the underlying loan terms, you may face a large prepayment penalty. If there is a good enough reason for you to expedite the sale of your property, a wrap around mortgage could be the solution.
The reason that these concepts could work for you is probably more likely because of a combination of the ideas presented above, along with your own circumstances and that of potential buyers.
If you have a property that you would rather sell on contract rather than rent out, you may have an existing mortgage on that property. The reason that you use the contract for deed may be related to the income limitations of the buyer. So if the deal makes sense to you for enough reasons, this is an example where you could use a wrap around mortgage even with some negative cash flow.
Something For A Flipper
Let’s say that you purchase a free and clear property for $100,000 at 5% interest and $5,000 down, amortized for 30 years. You could quickly sell it on a wrap around mortgage for $101,000 at 8% interest and $6,000 down, amortized for 30 years.
Your purchase payment is $509.98 monthly x 360 = $183,593.00. The sale price is $697.08 monthly x 360 = $250,947.48. The difference is $67,354.48. While it’s unlikely that the mortgages would exist for 30 years, this technique gives you another tool to maximize in ways that work for you.
How About A Private Lender?
A wrap around loan could be the answer when a prospective borrower doesn’t give you the confidence to charge your typical interest\ rate. If you are still looking for a way to complete the transaction, consider this example. Simply substitute the numbers that work for you.
You agree to lend $10,000 to someone who owns a $60,000 property with a $30,000 underlying loan at 8%. Take over the $30,000 loan and lend $40,000 in the form of a wrap at 15%. Using simple interest for one year you pay out $2400 on the $30,000 loan and collect $6,000 on the wrap loan. A $3600 profit on an investment of $10,000 gives you a yield of 36%.
Wrap Around Mortgages Can Work For Commercial Property (Business Notes Are Related)
At a basic level wrap around mortgages can be used for commercial property and the concepts above do apply. So that opens a boat load of possibilities. But commercial property is not the same as residential property.
What’s different? Commercial mortgages are written for shorter terms than residential mortgages, They typically have a balloon payment in five, seven or ten years. Then the commercial mortgage, which is the underlying mortgage in a wrap around mortgage, needs to be refinanced.
When you put together a wrap around mortgage for commercial property, it must be structured taking into account the remaining term of the underlying mortgage. As the property seller, look ahead to how long you hope to be involved with the property. Make sure that the documentation requires the mortgagor on the wrap around mortgage to take action that coincides with your plans.
Commercial mortgages also have covenants. What are mortgage covenants?
A loan covenant is a promise by the borrower to abide by certain terms and conditions outlined in the Loan Agreement.
Covenants can be positive, meaning the borrower agrees to affirmatively do something. Or, they can be negative, meaning the borrower agrees not to do something.
Generally, covenants fall into three buckets: financial, operational, or collateral. Commercial Real Estate Loan Covenants Explained
So the wrap around mortgage and note needs to take into account the underlying mortgage covenants and be written accordingly.
Examples of Commercial Seller Financing
Property Scenario Solution Outcome Property:Retail Strip Center Scenario:Owner of a fully-leased strip center wanted to retire but faced significant capital gains tax if selling outright Solution:30% down payment with seller financing for 70% over 10 years with 7.5% interest and a balloon payment after 7 years Outcome:Seller received some cash upfront while spreading out their tax hit, and buyer secured a good property without jumping through bank hoops Property:Industrial Warehouse Scenario:Manufacturing company needed a larger facility but had credit challenges due to recent expansion Solution:Seller provided 5-year financing with payments that started lower and grew each year as the business expanded Outcome:Seller secured a premium price, while the buyer obtained a facility with payments that matched their growth pattern Property:Office Building Scenario:Owner of a partially vacant office building struggled to find traditional buyers due to occupancy concerns Solution:Lower down payment (15%) with seller financing tied to improving occupancy rates Outcome:Buyer used their property management skills to fill the building, while the seller's loan became more secure as occupancy improved Source: Seller Financing Commercial Real Estate: An Overview While these examples are not specifically about wrap around mortgages, wrap around mortgages can be used in related ways. As the author stated: "These examples illustrate how flexible financing arrangements can solve problems that traditional lending simply can't address."
Are You Selling Only Commercial Property Or A Business Also?
Let's begin with the possibility that after you sell a property or a business and provide seller financing, you may eventually sell the real estate note and or the business note.
If you sell commercial property using a wrap around mortgage, the note can be sold just like other real estate notes created through seller financing.
If you use seller financing to sell a business and to also sell the commercial real estate at the same time, note buyers prefer that you create two notes. To do so you would create a business note collateralized by the business assets other than the real estate. And you would create a separate real estate note, perhaps as a wrap around mortgage.
Two separate notes give you flexibility in the timing of when the notes are created, how long you hold them, whether you sell one note or both and doing so by selling the whole note or a partial. Different combinations can be chosen, along with the details of each note, to meet your needs.
For example, a possible timeline could start with selling a small business, collecting a down payment and creating a business note to receive the remainder over seven years in 84 monthly payments.
Let’s assume that you are the owner of the building where the business is located. The business buyer isn’t ready to purchase the building so you lease it to them for starters.
One year after you sell the business, you sell 24 payments of the business note. That means that you are going to receive a lump sum of cash when you sell the partial, instead of 24 monthly payments. But during the first year after selling the business you were paid 12 monthly payments.
Three years after you sold the business, the note reverts back to you. You are then scheduled to receive the remaining 48 payments on the business note, but could decide to sell those also, or perhaps 50% of each remaining payment. Other options are possible.
Two years after you sold the business, the business buyer could be in position to purchase the building if you could provide creative financing. If you are still paying on a commercial mortgage for the building, a wrap around mortgage as presented above, could be an ideal answer. If you own the building free and clear, other versions of seller financing could be used.
Frequently Asked Questions
Who holds title in a wrap around mortgage?
It is common for title to transfer to the buyer when a wrap around mortgage is used. However if a wrap around mortgage is written in conjunction with a contract for deed, title is held by the seller until certain provisions are met.
Who benefits from wrap around mortgages?
Both buyer and seller can benefit from a wrap around mortgage. Sellers can benefit from a higher sale price, a higher interest rate than the underlying mortgage and keeping control of the underlying mortgage. Buyers benefit since seller financing can be arranged in a more affordable way without the challenges of qualifying for bank financing.
Can I sell a wrap around mortgage?
Yes the promissory note made in conjunction with a wrap around mortgage can be sold just like other real estate notes. It can be more challenging if there is a small amount of equity in the wrap note. If there is not enough equity in the wrap note, but the note holder is highly motivated to sell the note, they could accomplish this by paying cash in addition to the note.
More Resources For You
31 Steps To Success For Promissory Note Owners
The Pros And Cons Of Seller Financing - Part 2
34 Questions About Home Equity Lines Of Credit (HELOCs)
NoteSolutions Answers Your Questions About Promissory Notes
Selling a note or part of a note can be an alternative to taking on additional debt or liquidating other investments at a less than ideal time.
Have You Considered Selling A Note?
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As a note broker I will work with you to give you the best value for your note. This involves a more in depth analysis of your needs, your note and the best funding sources to approach on your behalf. This also includes presenting your situation to note buyers in the most favorable way. And my approach will not be limited by any one note buyer's requirements and note pricing. So TAKE ACTION NOW!
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