In a down economy, when obtaining home financing is extremely difficult, obtaining seller financing is often a great way to help each party involved on both sides of the transaction. One type of seller-assisted financing is the Wrap-Around Mortgage. In a comprehensive mortgage, the seller will have equity in their home at the time of sale, the borrower will pay them directly, and continue to pay their own mortgage, pocketing the rest to cover the equity that allows the borrower to finance. . Sound confusing? Click the link above for a more detailed breakdown of how these things work.
In a down economy, with financing difficult to come by, more and more people, both sellers and borrowers, want to take the “Wrap-Around” approach. While this type of financing certainly has its advantages, it definitely has its drawbacks as well, and these drawbacks are not small.
Let’s get this party started by listing the pros:
1. Often a borrower is creditworthy, but the tightest illiquid credit markets provide financing only to those with perfect credit, income and savings histories. Struggling to obtain financing makes a tough market even worse for those looking to part with their home. A Wrap-Around mortgage allows the seller to basically call the shots when it comes to who can and who can’t buy your home.
2. The ability to obtain seller financing, when direct bank financing is simply not an option, as detailed above, is certainly a great win-win for both parties. Also, if rates have risen substantially since the seller took out their original loan, this mortgage may allow the buyer to pay a below-market rate, a buyer’s advantage. The seller will keep a higher rate, compared to when you negotiated your initial financing, so you can keep the spread, a great advantage for the seller. For example, the seller’s initial 30-year fixed rate was 5%, but today the average 30-year fixed rate is 7%. The seller charges the borrower 6%, while the seller keeps the additional 1%, and the borrower pays 1% less than he would have paid if he obtained traditional means of financing. Win win!
If it sounds too good to be true, it probably is. Over time:
1. If the seller does not have an assumable mortgage and the bank learns that you have deeded your property to someone else, but have not requested that your mortgage be assumed by a new party, then you can “claim the loan” and foreclose . the property. The borrower may have been current on the payments, but is thrown out of his house. In a tough market where people don’t make their payments, banks (unsurprisingly) care less about the source of the payment and much more concerned about whether or not the payment actually goes through. So don’t expect this to be enforced if the mortgage stays current.
2. If the bank has a “due to sale” clause and it is not disclosed to the bank that the property has changed hands, the same problem as listed in #1 may occur. The borrower is current on the loan, but seller never informed bank of sale, then mom bank gets mad and forecloses. The poor borrower lives in a box for a few months after moving into his new home and paying the seller on time every month.
3. The biggest concern/disadvantage for the seller is that the borrower does not pay his mortgage on time. A benefit to a wrap-around vs. a straightforward 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. It’s not fun.
4. Some “wrappers” have the seller pay the bank directly or through a third party. If this is the case, and the borrower falls behind, then the seller has bad credit and is at risk of losing the house.
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Wraps are great if both parties follow the rules. It is important that the borrower and the seller are aware of the risks of an “involvement” and make appropriate preparations to mitigate them.