Financing (part 7) Wrap Arounds Loans (also known as all inclusive deeds of trust)

A wrap around loan, commonly referred to as a wrap envelopes an existing loan and any equity into one loan payment. This is sometimes rather difficult process to grasp, so if you would like to ask any questions or seek clarification on key points, email me at whflood@yahoo.com and I will be happy to answer your questions.

So...How Does a Wraparound Loan work?
Let’s say a seller owns a property worth $100,00 and has an existing loan of $60,000. That loan is at 6% and has 23 years remaining to pay. The payment is $400 a month. He is willing to finance the remaining $40,000. But, rather than setting it up where you take over the existing loan and he accepts a second mortgage, he wants to set it up as a wraparound loan. It would work like this:

He sets up the loan terms on $100,000 at 7.5% for 30 years, payable at $700 a month. You pay him the $700 each month. He pays out his original mortgage payment of $400 and keeps the remaining $300 for payment on his equity.

You may be asking, “what’s the difference between the wrap and him just accepting a 2nd mortgage?” Actually, there are several reasons. First, he is in a more secure position because he is ensuring the underlying first is getting paid. And, if you noticed an odd detail or two, it’s actually to his financial advantage – he pays out at 6%, but collects at 7.5%. Thus, he is getting 1.5% on money that isn’t even his! And, the existing loan is due to be paid off in 23 years, but you would be paying for 30 years, so he gets 7 years of money even when the underlying loan is paid off!

Now, wraps can be tricky and there are some pitfalls such as the original owner failing to pay the underlying loan. It’s a good idea to get a trust company or bank trust office involved to make sure everyone is doing what they say. You wouldn’t want to make your payments only to find out the seller isn’t paying the underlying loan! So, you’d set it up so your payment would be made to the trust office. That office would, in turn, pay the underlying loan and send the seller his proceeds every month. It will cost a few dollars a month to set that up, but it is well worth it!

Next time, we’ll be continuing the discussion on creative financing by looking at Land Contracts, Options, Lease options & lease purchases, Private money & partnerships (equity sharing), Hard money, Selling notes, and the use of unsecured credit lines.

Until next time, this is Bill Flood, your host for the Coast to Coast Real Estate Investor. Live your real estate dreams!