A Bad Wrap! by David Reed

We’ve all heard the term, “wrap around,” but what exactly does it mean? A wrap around mortgage, or simply a “wrap,” is an agreement where the buyer of a property makes monthly payments to the seller of a property, who then pays the original lender each month. This is perceived as a way of an owner “selling” a property to a buyer without the buyer obtaining conventional financing.

While a wrap can be viewed as a traditional sale, in reality it’s anything but.

All mortgage loans contain a “due on sale” clause. That means if the current owner of the property sells or otherwise transfers ownership then the lender can immediately call the loan in completely. In other words the lender says, “Okay, you sold the property, we want our money.” In the past, the due on sale clause was not as prevalent, but now all mortgage loans contain such language.

So how would the lender ever know? First, if it’s a legal transfer of ownership, the sale would be recorded and therefore become public record. Lenders would receive notice from the companies they employ to monitor such transactions. The lender could also find out following the change of the original owner’s mailing address.

Now say the owner of the property tells you that they could “carry the note” for you if all you did was make monthly payments directly to him or her. If your agreement was to pay $2,000 per month, those funds could then be directly applied to their original mortgage payment.

Many wrap arrangements require a substantial down payment from the buyer along with the agreement to make a mortgage payment above and beyond what the real mortgage payment requires. Wraps are typically made because the buyer, the seller or both are unable to secure financing. While it may appear to be a solution to a tough problem, a wrap around mortgage is inherently problematic (and generally not worth the trouble).

For example, what would happen if the seller was notified by the lender that an illegal transfer of ownership took place and the lender activates the no-sale clause and wants all its money back?

First, the seller would have to immediately refinance the current note, which would be nearly impossible because the property would have been sold.  A new lender wouldn’t finance the new deal nor would the buyer, because the lender wouldn’t recognize the new owner.

Second, and perhaps more importantly, what if the buyer indeed made the monthly payments on a regular basis but the owner somehow fell behind and didn’t make the payments to the original lender? The lender would be forced to foreclose on the original owner, meaning that the new buyer would lose the down payment and payments to the original owner!

A wrap around isn’t a “last resort” method of financing, it’s a “no resort.”  Violating the terms of a mortgage, having the mortgage called in by the lender and the buyer losing his down payment and presumed equity with no legal ownership rights is a losing proposition for everyone!