Wrap-Around Financing Can Help Make a Sale in a Slow Market
In a slow real estate market, would-be sellers and potential buyers begin to think about creative financing.
Last week, I wrote about transactions in which the seller holds the entire mortgage, a type of arrangement that is treated as an installment sale for tax purposes. This type of creative financing works best when the seller has no mortgage or a small one.
There's another approach, known as a wrap-around mortgage, that can be used in some situations where the seller has a larger existing mortgage.
Here is how it works. Say you want to sell your house for $500,000 and have an existing $200,000 mortgage loan with an interest rate of 5 percent. You have found a buyer who has sufficient income but might have difficulty obtaining a mortgage.
You agree to sell the house. At settlement, you will sign a deed over to the buyer to be recorded on land records. Your buyer will give you $50,000 in cash for the down payment.
But instead of taking out a standard mortgage for the rest of the purchase price, the buyer will sign a promissory note to you for $450,000, the difference between the sales price and the down payment. This loan will carry an interest rate of 6 percent. The monthly payment, based on a 30-year amortization, would be $2,698.00. This note will be secured by a second deed of trust recorded against the property.
The buyer would then make the monthly payments directly to you. You in turn would continue to make your payments to your lender on that $200,000 first mortgage.
From the buyer's point of view, these payments would be just as they would be from any commercial mortgage lender, although at a lower interest rate. Additionally, the buyer would not have to pay the various lender closing charges.
As the seller, you would make a small profit. You are paying off that old 5 percent mortgage but are receiving 6 percent from their buyer.
Even more important, offering this type of financing might be the key to making the sale.
This kind of transaction is called a wrap-around mortgage because the second trust is wrapped around the first. It has some risks, though.
First, the seller should have an assumable mortgage on the property. While these are not as common as they once were, there are still many Department of Veterans Affairs or Federal Housing Administration assumable loans on the books. Some adjustable-rate mortgages are also assumable.