Q: We are in need of money, and we have a lot of equity in our house. Our existing loan is approximately $75,000 at 9 1/2 percent, and we are quite reluctant to refinance when rates are higher than 16 percent. Recently, a commercial lender offered us $45,000 at 12 1/2 percent, but only on the condition that we sign a second deed of trust in the amount of $120,000 at 12 1/2 percent, to be paid in full at the same time that our first trust is owed. The lender has told us that this is known as a "wrap-around" mortgage, and that we will make one payment to the lender and they will make the payment to our first mortgage holder. We like the idea of getting 12 1/2 percent money, but want to know whether you think this is a good idea.

A: I think the plan you outlined is a terrible idea. Ou would be obligating yourself legally to pa a new not of $120,000, in addition to the first note of $75,000.

The wrap-around concept is very common in commercial transactions, and only recntly, with high, volatile interest rate has become a financing tool for residential transactions.

Usually, the wrap-around is used in a situation whereby you sell your house with an assumable VA or FHA mortgage to a purchaser, and you take back a second trust in an amount that includes the amount of the first trust. Ou agree to make the ;mortgage payments on the first, and you get a little extra interest because of the difference in the rate on the first and the wrap-around.

Bear in mind that a wrap-around, for all practical purposes, is a second trust.

Recently, there have been a number of commercial lender who are getting into the kind of wrap-around situation you discussed above. Let's look at the ral yield to the lender:

If the existing loan is $75,000 at 9 1/2 percent, the wrap-around is $45,000, and the new mortgage is $120,000 at 12 1/2 prcent, the rate of return (3 percent of $75,000, or $2,250, plus 12 1/2 percent of $45,000, or $5,625) is $7,875. Divide this figure by $45,000 and you get the real yield to the lender -- 17 1/2 perdent, which of course is closer to the yield commercial lenders would like to get.

However, the structure that you ahv outline is quie dangerous. First, as discussed earlier, you are obligating yourself to pay a lot ;more than the $45,000 your are borrowing. If your lender sells the note in the open market, a third-party pruchaser without knowledge of the transaction would be able to rely on the fact that this is a second trust in the amount of $120,000.

Second, and more importantly, what guarantee do you ahve that the lender will in fact make the payments to your first mortgage holder? If you enter into some form of wrap-around, it is absolutely important that you send the second (wrap) lender two checks. One check -- made payable to your first mortgage lender -- will be for the amount of the first turst, and the other check will be for the difference on the second trust. This way you will be sure that the chick is in fact sent to your first lender. Check your bank statments periodically to make sure the checks are returned.

It is also important that you review the terms of your first deed of trust. ysome lenders -- espedcially on older loans -- do not permit secondary financing. Although it is doubtful that you will have such a prohibition, before you take out a second trsut (the wrap), satisfy yourself that this is permitted.