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Use Caution When Buying a Home Using a Wraps Agreement
While flipping properties or renting them out may seem like a good way to make money in real estate, those aren’t the only ways. There’s also something called wrap-around mortgages, often called “wraps” for short or real estate wraps. These mortgages allow a person to sell their home to another person, who then takes over making payments on the existing mortgage directly to the seller.
How these mortgages work is a little complicated to understand at first. Say you owe $300,000 on your home, but would like to sell it for $600,000. You may make an agreement with a buyer that they will pay you $50,000 in cash up front as a down payment, and agree to make the monthly mortgage payment on the first trust, which is basically what you still owe - $300,000. On top of that, they’ll also sign a promissory note to you in the amount of $550,000, which is the difference between the cash they put down and the price that you originally wanted to sell it for. The interest rate is also outlined in the agreement, and is often a percent or two higher than the original mortgage on the home.
If the seller doesn’t have an assumable mortgage on the property, a wrap-around mortgage can be quite risky. While these types of mortgages aren’t as common as they once were, there are still some loans and adjustable rate mortgages that are assumable. If the original mortgage is not assumable, both the buyer and seller run the risk of having the original lender foreclose on the property using what is known as a “due on sale” clause. This means that if the remaining amount on the mortgage isn’t paid in full before the property is transferred to another party, the lender can foreclose on it.
For those purchasing a home using a wraps agreement, there is always the risk that the person you purchased the home through will not make the payments to the mortgage company on time. If this happens, even though you’re paying the seller on time as agreed, the bank can still foreclose on the property. Even though you are placed on the title, the seller you purchase the property from is still in first place of the land records. In an attempt to avoid this happening, buyers should insist that the seller provide them with proof that the payments are being made on time.
While potential homebuyers that find themselves unable to obtain any other form of financing can benefit from this method, as can the sellers, both sides should exercise caution when considering using wraps for financing.