Wrap Mortgage Basics for Investors

How does a wrap mortgage work?

Three pieces are in play:

1. The underlying loan. The seller's existing mortgage, which stays in place and in the seller's name.
2. The wrap note. A new promissory note from the buyer to the seller for a larger amount, usually the purchase price minus the buyer's down payment.
3. The payment flow. The buyer pays the seller on the wrap note. The seller pays the underlying lender out of that payment.

In some states the security instrument is called an all-inclusive trust deed. The names vary; the structure is the same.

How is a wrap different from subject-to?

In a subject-to purchase, you take title and make the seller's existing loan payments yourself. There is no new note to the seller for the underlying balance. In a wrap, you owe the seller on a new note, and the seller handles the underlying loan.

Does the due-on-sale clause apply to a wrap?

A wrap involves a sale and transfer of the property, so the existing loan's due-on-sale clause can come into play. Federal law defines that clause as giving the lender the option to call the loan when the property is transferred without consent (12 U.S.C. 1701j-3, Cornell LII). The statute's exemptions cover family, death, divorce, short-lease and certain trust transfers on small residential properties, not sales to investors. Plan for that risk the same way you would on a subject-to deal. Our post on the due-on-sale clause and subject-to deals goes deeper.

What are the risks on each side?

If you are the buyer on a wrap: your biggest risk is that the seller collects your payment and does not pay the underlying lender. A third-party loan servicer that collects your payment and pays the underlying lender directly reduces that risk, and many attorneys recommend one.

If you are the seller on a wrap: your name stays on the underlying loan, and you depend on the buyer's payments to keep it current. If the buyer stops paying, you still owe the lender.

Wrap rules and disclosure requirements vary by state. Get advice from a real estate attorney before offering or accepting terms.

A worked example

Example only, with hypothetical round numbers and hypothetical rates. A seller owes $150,000 on a loan at a low fixed rate. You agree to buy at $200,000 with $20,000 down. The seller gives you a wrap note for $180,000 at a higher rate.

• Each month you pay the seller on the $180,000 wrap note.
• The seller pays the lender on the $150,000 underlying loan out of your payment.
• The seller earns the difference between the two payments and the $30,000 of extra balance over time.

If the $20,000 down payment is the problem, that is a cash-to-close gap. Axelrad's gap funding starts at 2.5% and is repaid several ways, typically after closing through a seller carry, with the repayment structure set before closing.

What should a wrap agreement cover?

1. The underlying loan's balance, payment and status, verified with a payoff or statement.
2. Who pays the underlying loan, and how payment is proven each month.
3. Servicing arrangements, ideally through a neutral servicer.
4. What happens if the underlying lender calls the loan.
5. Default remedies on both the wrap and the underlying loan.
6. Insurance and taxes: who pays, and how both parties are named.

Wrap documents are not standardized, and state rules vary. Use a real estate attorney and a title company that handles wrap closings.

Key takeaways

• A wrap is seller financing that keeps the seller's existing loan in place underneath a new, larger note.
• The buyer pays the seller; the seller pays the underlying lender.
• A wrap transfers the property, so due-on-sale risk applies.
• A neutral loan servicer reduces the risk that payments do not reach the underlying lender.
• Cash needed at closing on a wrap can be a candidate for gap funding.

Funding the cash side of a wrap?

If a wrap deal is agreed and the cash at closing is the missing piece, send the deal to Axelrad with the terms and the repayment plan, and the team will look at gap funding.