In a down economy, when obtaining home financing is extremely difficult, getting seller financing is often times a great way to help each party involved with both sides of the transaction. One type of seller-assisted-financing is the Wrap-Around mortgage. In a wrap-around mortgage, the seller will have equity in their home at the time of sale, have the borrower pay them directly, and continue to pay on their own mortgage, pocketing the remainder to cover the equity that they let the borrower finance. Sound confusing? Click on the link above to get a more detailed breakdown of how these things work.
In a down economy, with financing difficult to achieve, more and more people – both sellers and borrowers – would like to take the “Wrap-Around” approach. While this type of financing certainly has its advantages, it definitely has its drawbacks too, and these drawbacks are not small.
Let’s get this party started by listing the Pros:
1. Often times a borrower is credit-worthy, but tightened, non-liquid credit markets are providing financing only to those with perfect credit, income, and savings history. Having a difficulty in obtaining financing makes a difficult market even worse for those looking to part ways with their house. A Wrap-Around mortgage, allows the seller to basically call the shots when it comes to who can and cannot purchase their home.
2. The ability to get seller financing, when direct bank financing simply is not an option, as detailed above, certainly is a big plus for both parties. Additionally, if rates have gone up substantially since the seller got their original loan, this mortgage can allow the buyer to pay them a below-market rate, a plus for the buyer. The seller will maintain a higher rate, compared to when they negotiated their initial financing, so they can keep the spread, a big plus for the seller. For example, the seller’s initial 30-yr fixed had a rate of 5%, but currently the average 30-yr fixed is 7%. The seller charges the borrower 6%, while the seller keeps the extra 1% and the borrower pays 1% less than they would have, if they were to obtain traditional means of financing. Win Win!
If it sounds too good to be true it probably is–Con time:
1. If the seller does not have an assumable mortgage and el banco finds out that they have deeded their property to someone else, but have not requested their mortgage be assumed by a new party, then they may “call the loan” and foreclose on the property. The borrower may have been current on payments, but gets kicked out of their house. In a difficult market when people are not making their payments, banks (not surprisingly) become less concerned with the source of the payment, and far more concerned with whether or not the payment is being made. So don’t expect this to be enforced if the mortgage is being kept current.
2. If the bank has a “due on sale” clause, and it is not revealed to the bank that the property has changed hands, the same issue as listed in #1 can occur. The borrower is current on the loan, but the seller never informed the bank of the sale, then mama bank gets angry and forecloses. The poor borrower is living in a box a for a few months after moving into their new home and paying the seller on time every month.
3. The biggest concern/con for the seller is that the borrower doesn’t pay their mortgage on time. One benefit to a wrap-around vs. a straight mortgage assumption is that the seller at least knows when the borrower is paying late and can make the payment to the bank for the borrower. However, in a case like this, the seller is essentially paying for someone else to live in a home. Not fun.
4. Some “wraps” have the seller either paying the bank directly or through a third party. If this is the case, and the borrower is late, then the seller has their credit dinged and risks losing the home.
Wraps are great if both parties play by the rules. It’s important for the borrower and seller to know the risks of a “wrap-around” and make the proper preparations to mitigate them.