| A 'wrap-around" mortgage is an "old school" | | | | In addition, you can deduct all interest paid on a |
| financing technique. It isn't as popular as it once | | | | yearly basis as well as the real estate tax. Of |
| was, but it still has definite advantages for the | | | | course, as a shrewd investor, you can also use |
| creative real estate investor in a slow market. It | | | | wrap around mortgages to turn around properties |
| also has advantages for buyers facing foreclosure | | | | quickly at a profit. |
| or who have poor credit. | | | | There are advantages for the borrowers as well. |
| In basic terms, a wrap-around is a loan deal in | | | | Perhaps due to the current lack of sub prime |
| which you, as the investor, assume responsibility | | | | financing, they can't get financing at an acceptable |
| for an existing mortgage. Here's an example: | | | | rate so they opt for the wrap-around mortgage |
| The Smiths have a $70,000 mortgage on their | | | | method. By choosing this route, they also avoid |
| home. They sell it to you for $100,000. You pay | | | | the hassle of conventional mortgage procedures |
| $5,000 down and then borrow $95,000 on a new | | | | (closing costs, etc.). And, as mentioned earlier, |
| mortgage that they grant you. This new | | | | they may be facing foreclosure, and a |
| mortgage "wraps around" their original $70,000 | | | | wrap-around sale can spare them the |
| mortgage because there are still payments to be | | | | embarrassment of being foreclosed upon. |
| made on the old mortgage. | | | | As with any financial tool, there are disadvantages. |
| So, what are the main advantages to you as an | | | | Wrap-arounds can only be used with assumable |
| investor? The first is leverage. Here's an example | | | | mortgages (i.e., existing borrowers can transfer |
| to illustrate how you gain leverage with a | | | | their obligations to qualified house purchasers). |
| wrap-around mortgage: | | | | Bad News: As of this writing, there are no loans |
| Assume that the Smiths original $70,000 | | | | that can just be assumed without the written |
| mortgage has an interest rate of 6%. Assume | | | | permission of the lender. |
| the new $95,000 "purchase money" mortgage | | | | So, if a mortgage has a "due on sale" clause, and |
| has a rate of 8%. The Smith's "equity spread" is | | | | today most do, this means that the existing |
| $25,000 ($95,000-$70,000) and they will earn 8% | | | | mortgage can't be assumed without the original |
| on that portion. But, the Smiths also are earning | | | | lender's permission. The result--the original lender |
| the difference between 8% the Buyer pays on | | | | can decide to call the loan. This is perhaps the |
| the full amount and 6% they have to pay on the | | | | biggest risk to you as an investor. |
| $70,000 underlying loan that remains in place. So, | | | | I would not recommend that anyone take over a |
| the Smith's total return is a full 8% on the | | | | mortgage in this fashion without first getting |
| $25,000 and 2% on the 70,000 that they still | | | | written permission from the lender to do so. |
| owe. In fact that 2% return is huge because it is | | | | There is essentially a "due on sale jail", despite |
| really not their money, they still owe it on the | | | | what the real estate gurus of today may preach. |
| first mortgage. | | | | Proceed with extreme caution! |
| Question: How would you like to earn 2% on | | | | It's also important to remember that the original |
| someone else's money? | | | | lender has first legal rights. So, if the home |
| Answer: All day long! | | | | owners fail to make mortgage payments to the |
| So, through this strategy, you've taken the | | | | original lender, the original lender can initiate |
| existing mortgage's lower interest rate(6%) and | | | | foreclosure procedures. |
| leveraged it into a higher yield (8%) for yourself. | | | | |