If you don’t want to rent your house and become a landlord, another creative way to sell your house is with a wrap-around mortgage, which is a version of owner financing.
Just like in regular owner financing, the seller acts as the bank to the new buyer, “wrapping” a new mortgage around his or her existing mortgage.
- Home value: $200,000
- Seller’s mortgage amount: $180,000
- Seller’s existing interest rate: 4.25%, fixed
- Purchase price to investor: $110,000
The owner can sell the house to a new buyer with the following terms:
- Sales price: $205,000
- Down Payment: $10,000
- New “wrap” mortgage amount: $195,000 (the balance on the new loan)
- New interest rate: 6.5%
In this example, the homeowner keeps the down payment of $10,000 (which can be helpful for covering closing costs), and collects the monthly mortgage payment of $1,056 (6.5% on the $195,000 loan), which is used to pay the existing mortgage payment of $637 (4.25% on the $180,000 loan) resulting in $419/month in positive cash flow. Every deal is different…this just happens to be a great one.
The buyer becomes responsible for taxes and insurance, so the seller needs to create a new escrow account for these expenses. Sometimes they may choose to pass the existing escrow to the new buyer. Taxes and insurance are the most complex elements of a wrap-around mortgage and it’s imperative that they’re structured properly.
Just like with regular owner financing or leasing, it’s possible that the end buyer stops making payments. In this case the seller has to foreclose on the property and repossess the house. To sell it again the seller will have to make any needed repairs to bring it back up to retail market conditions. This scenario happens the majority of the time, 70% by some estimates, with these types of transactions. Selecting an appropriate end buyer is one of the key factors to making sure the transaction is a success.
At Second Chance Offers we have extensive experience with wrap-around mortgages and other forms of owner financing. One of our strategies is to list a home for a client and simultaneously offer the home for sale with owner financing (which may attract more buyers faster).
Can any house be sold with a wrap?
Pretty much, yes. Even if there are multiple liens, a new wrapped mortgage can be created and the home can be sold. In some cases, a seller can even create a wrap-around mortgage in which the monthly payment is less than the underlying mortgage payments – resulting in negative cash flow. Why? Because it may be the only way to get the house sold. Of course in these situations, there may be better options. Call us!
How long does the wrap last and what happens when the buyer sells or refinances?
Most sellers will structure this so that the buyer is required to refinance the wrapped loan after 3-5 years or sell the home. If the buyer fails to do so, the seller can structure penalties in the contract such as raising the interest rate, and monthly payment, or getting the house back. At the time that the home is refinanced (or sold) the underlying loan is paid off and the remaining balance (a profit) is paid to the seller. In the example given above, the seller would get $15,000 when the home is refinanced. Investors call this “the back end profit”.
Can the lender call the loan?
Technically yes, but practically no. Almost all mortgages have a “due on sale” clause that gives the lender the right to call the loan due when the house is sold. Practically speaking, though, this is extremely rare in cases where the loan payments have been and continue to be paid on time. Think about it – logically it doesn’t make sense to disrupt a good thing: a performing loan. Also, it would take the lender some effort to even know that a sale took place.