Wrap around mortgages – Seller Financing
Wrap around mortgages
A wrap around mortgage is in some ways similar to a second mortgage. It is inferior in priority to the first mortgage. (If you do not know what that means, click here.)
Here’s how it works and why you would use it.
Let’s say you own a home worth $100,000 and there is an assumable first mortgage on it in the amount of $60,000. The interest rate is 7% per annum. It was a 360 month (30 year) mortgage. The payments are $539.30 per month. There are 180 payments left.
You sell the house and are willing to take back financing from a borrower who gives you a $10,000 down payment.
You could take back a second mortgage of $30,000 at say 10% per annum for 180 months. You would get $322.38 a month. (If you do not understand how to calculate the payments click here).
But instead you could create a mortgage that “wraps around” the first mortgage for $90,000 at 10% per annum for 180 months. The payments on this mortgage are $967.14.
In this scenario, you continue to make the first mortgage payments. You now get to keep $967.14 – $539.30 = $427.84 instead of $322.38.
This happens because you are profiting on the interest rate spread between the 7% you are paying and the 10% that your buyer is paying.
Why would a buyer agree to this? Perhaps interest rates have gone up in the meantime so they couldn’t get financing at a better rate. And remember, you have far more leverage on the buyer if you are holding financing.
Apart from the profit on the interest rate spread, there is another benefit to you. You know immediately if the buyer is not making his payments. Because you are getting them, not the lender, who may take months before they let ou know. In fact the first time you know is when you are served with foreclosure papers.
There is a disadvantage to the buyer. Apart from the interest rate spread, they are taking a risk that you may get their payment and not make the first mortgage payment. Thus they end up in foreclosure even though they have always paid.
Can you make the term of the wrap around mortgage different from the term remaining on the mortgage? Yes.
But if you make the term on the wrap mortgage shorter, you could be in a position when your mortgage is paid off and you still owe money on the first mortgage. You will have to pay this first mortgage off in full as the buyer has paid off their mortgage with you.
How about if you make it longer. Also OK, You could have a $90,000 wrap mortgage at 10% per annum for 240 months. The payments would be $858.52. For the first 180 months you would get to keep $858.52 – $539.30 = $329.22. But for the last 60 months the first mortgage is paid off in full and you keep the whole $852.52.
As always, consult a competent, local professional for advice.
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