Today’s post is written by Michael Green, Commercial Loan Originator for Counsel Mortgage Group, LLC.
No, we’re not talking about the closing of the Mueller investigation of President Trump for collusion, obstruction, etc. This is a wrap of a different kind.
We’re talking about a wraparound mortgage.
A wraparound mortgage is a type of junior (subordinate) loan which wraps around, or includes, the current note due on the property. The wraparound loan will consist of the balance of the original loan, or more, plus an amount to cover the new purchase price for the property. These mortgages are a form of secondary financing. The seller of property receives a secured promissory, which is a legal IOU detailing the amount due.
A wraparound mortgage is also known as a wrap loan, overriding mortgage, agreement for sale, a carry-back, or all-inclusive mortgage.
Wraparound mortgages are a form of seller financing where instead of applying for a conventional bank mortgage, a buyer will sign a mortgage with the seller. The seller then takes the place of the bank and accepts payments from the new owner of the property.
Frequently, a wraparound mortgage is a method of financing the purchase of a property when an existing mortgage can’t be paid off by the seller. The total amount of a wraparound mortgage includes the previous mortgage’s unpaid amount plus additional funds required by the lender, if any. The borrower/buyer makes a larger monthly payment on the new wraparound loan, which the lender (the seller) will use to pay the original note plus provide themselves a monthly increase in cash between the payments. Depending on the wording in the loan documents, the title may immediately transfer to the new owner or it may remain with the seller until the satisfaction of the loan is completed.
Since the wraparound is a junior mortgage, the superior loan will have priority. In the event of the sellers default, the original mortgage would receive all proceeds from the liquidation of the property until it is all paid off.
Most seller-financed loans will include a spread on the interest rate charged, giving the seller additional cash from the buyers monthly payment.
For example, Mr. Smith owns a shopping center which has a mortgage balance of $500,000 at 4% interest. Mr. Smith sells the center for $800,000 to Mrs. Jones who pays Mr. Smith $200,000 down and obtains a $600,000 mortgage from Mr. Smith at 6% interest. The $200,000 down is insufficient for Mr. Smith to pay off his $500,000 loan, so Mrs. Jones makes payments to Mr. Smith on the $600,000 mortgage who uses those payments to service his original 4% mortgage. Mr. Smith has a monthly cash pick-up from the spread between the two interest rates. (You can also affect the monthly payment by reducing the amortization rate on the wrap vs. the original mortgage, or varying both the interest rate and amortization rate differentials to produce the desired outcome.) Depending on the loan paperwork, the property’s ownership may transfer to Mrs. Jones. (Beware of a due-on-sale clause in the original note.) However, if Mr. Smith defaults on the 1st mortgage, the lender of the senior loan may foreclose and reclaim the property, leaving Mrs. Jones out her $200,000.
Aside from the obvious arithmetic benefits, there are risks to this type of financing that may not be immediately obvious, but rest in the convenants of the individual notes. Thinking this through a bit and you’ll come up with a variety of “what ifs”.
But a more obvious question is “Why would somebody do a wrap when they can simply go to the bank?” The answer lies in the question … they can’t go to the bank … and for a variety of reasons.
For the last decade or so we’ve been spoiled by relatively easy bank lending terms. These have been accelerated over the last couple years with rising interest rates (making lending more profitable for banks). As we inch closer to the end of the credit cycle (and other cycles) we can expect conventional lenders to raise the bar for loan approvals. In such an environment, wraps may become a more viable financing method to convey properties. All it takes is a willing buyer and a willing seller, and someone who knows their way around wraps!
Incidentally, wraps can be used for residential real estate also.
But a cautionary note: Don’t try this at home kids … leave it to the professionals!
For specific representation, give us a call at Counsel Mortgage.
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Counsel Mortgage Group®, LLC
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Michael Green is a Commercial Loan Originator for the Counsel Mortgage Group®, LLC.
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