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Are Wraparound Mortgages a Good Investment Strategy?
In the 1970s, mortgage rates were fairly high and many people had to face the facts that they couldn’t get a mortgage. This situation inspired consumers to create something known as a wraparound mortgage, or “wraps,” which are not so prevalent today.
The way they work is a bit complicated, but basically, the owner of a property will hold the note or mortgage while the buyer signs a promissory note in the amount of the “sale.” The buyer will also be required to sign a deed of trust which will be recorded in the local land records and which gives the buyer the right to deduct the interest they are paying to the seller on the loan. This means that the owner keeps the first deed of trust and the seller’s second is “wrapped” around it.
Is this a safe proposition? There are a few risks that a buyer is running when doing real estate wraps. The first, and foremost, is that many banks or mortgage companies impose a “due on sale” feature to their loans. This means that should the lender learn of the arrangements between the buyer and seller the entire amount of the outstanding mortgage could be called by the lender. Additionally there must be some arrangements made, on paper, to ensure that the first mortgage lender is getting their monies from the owner or else the entire property could be forfeited to a foreclosure.
Is this a wise way to invest in a property? It is certainly a creative financing technique that would allow an investor to remain free of any paper trails that might limit their ability to borrow from a bank or lending agent. Additionally, the existence of the wrap can usually get a third party loan that delivers higher interest yields to the owner and the lender.
What does this all mean? Basically, the investor would stack their loan on top of the owner’s existing loan; this allows the owner to retain the security of the mortgage loan and its implications of ownership which includes increased income from the larger interest on the second loan. It would simultaneously make the mortgage an assumption of the buyer which means the owner would be free of the monthly payment and would have a comfortable income stream or monthly profit provided by the amount that the buyer is paying. While this is a clear-cut strategy for investment, the ever-present risk of the “due on sale” may not make it a constant “win-win” for all involved.