Good morning, everyone! I’m Ryan, and today we’re diving into another episode of “Grant Teach Me Something.” In this session, we’ll get creative and move beyond the traditional wholesaling, flipping, and renting mindset. Today, we’re focusing on wraparound mortgages, a strategy often overlooked and misunderstood. So, let’s get started.
In real estate investing, we often find ourselves sticking to tried-and-tested methods like wholesaling, flipping, and renting. But sometimes, thinking outside the box can lead to new opportunities. One such method is the wraparound mortgage. You’ve probably heard the term thrown around casually—”just wrap it”—but what does it really mean? Today, we’ll break down wraparound mortgages in a simple, easy-to-understand manner.
Understanding Wraparound Mortgages
What is a Wraparound Mortgage?
A wraparound mortgage is a type of creative financing. It allows an investor to take existing debt on a property and “wrap” new debt around it. This essentially means that your buyer will pay you more than what you’re paying monthly on the original mortgage. For example, if you have a $400 monthly mortgage payment, but your buyer is paying you $750 a month, the difference is your profit. This difference, or “wrap,” is where you make your money.
Visualization
To help you visualize, imagine the underlying debt on a property as a horizontal line. Your buyer’s payment sits above this line, creating a “wrap.” The space between your payment and the buyer’s payment represents your profit, equity, and cash flow. This is your “wrap donut.”
The Two LLC System
Benefits
Using a two LLC system offers multiple benefits. It allows you to manage foreclosure processes more efficiently and take advantage of favorable interest rates. Holding properties in separate LLCs can also protect your assets and provide flexibility in management.
Debt Creation on Free and Clear Properties
Even if you own a property free and clear, the two LLC system can help you create debt on that property. This strategy allows you to structure a wraparound mortgage, giving you financial leverage and flexibility.
Breaking Down the Wrap Mortgage
Understanding the Underlying Debt
Let’s break down the details of the underlying debt:
- Loan Amount: $80,000
- Interest Rate: 4.25%
- Monthly Payment: $400
- Remaining Term: 22 years
Selling to the Buyer with Wraparound
When you sell with a wraparound mortgage, you aim to increase various components:
- Purchase Price: $100,000
- Interest Rate: 9.5%
- Monthly Payment: $750
- Term: 30 years
Calculating Profits
Down Payment and Monthly Cash Flow
Typically, you’ll ask for a 10% down payment. So, if the purchase price is $100,000, the buyer pays $10,000 upfront. Additionally, you’re making a monthly profit from the difference between what you’re paying ($400) and what you’re receiving ($750).
Equity and Long-Term Profits
In our example, you owe $70,000, but your buyer owes you $90,000, resulting in $20,000 of equity. Over time, this equity and monthly cash flow add up. Assuming both notes go to full term, your earnings can be substantial.
Advantages Over Rental Properties
No Landlord Responsibilities
One major advantage of wraparound mortgages over rental properties is that you don’t have landlord responsibilities. You won’t need to worry about repairs, taxes, or insurance. Your role is simply to collect payments and handle any issues that may arise with the buyer.
Long-Term Commitment Without Hassles
With a wraparound mortgage, you often get a 30-year commitment from buyers, reducing the need for frequent tenant turnovers and property management headaches.
Addressing Problematic Sellers
Risks and Disclosures
One of the risks in real estate investing is dealing with problematic sellers. Proper disclosures and legal paperwork are essential. If a seller discloses all potential issues upfront, you can mitigate the risk of unexpected surprises.
Power of Attorney and Authorizations
Gaining power of attorney and necessary authorizations from the seller allows you to manage the property more effectively and prevent the seller from doing anything that might jeopardize the deal.
Navigating the Due on Sale Clause
Definition and Risks
The due on sale clause can be a concern in subject-to deals. This clause allows the lender to demand full repayment of the loan if the property is sold or transferred without their consent.
Strategies for Mitigation
There are several strategies for dealing with the due on sale clause:
- Deeding back to the Seller Temporarily: You can temporarily deed the property back to the seller to satisfy the lender before taking it over again.
- Using Trusts: Putting the property into a trust can provide a temporary shield.
- Private Money/Refinancing: Using private money to refinance the property can help pay off the existing loan and avoid triggering the clause.
Capital Requirements
Differing Opinions
There are varying opinions on whether you need capital to start with wraparound mortgages. Some argue that you can start without any money, while others believe having capital or backing is crucial.
Setting Aside Down Payments
Regardless of the approach, setting aside the down payment you receive is a safe practice. This reserve can help you manage any unexpected costs or delays in payments from buyers.
Private Money Partners
Private money partners can also be a valuable resource. Investors with capital are often willing to partner in deals, providing you with the financial backing needed to succeed.
The Overall Process
Contracting the Seller to Wraparound Sale
The process involves several steps, from contracting the seller to selling the property with wraparound financing:
- Contract the Seller: Secure the property with clear terms.
- Prepare Necessary Paperwork: Ensure all legal documents are in order.
- Market the Property: Find a qualified buyer willing to agree to the wraparound terms.
- Close the Deal: Finalize the sale and start collecting payments.
Compliance and Regulations
Dodd-Frank Regulations
Compliance with Dodd-Frank regulations is essential when dealing with wraparound mortgages. This law defines the requirements for originating mortgages and ensures consumer protection.
RMLO Licenses
Using a Residential Mortgage Loan Originator (RMLO) ensures you’re complying with legal requirements. An RMLO handles the loan application process and helps negotiate terms.
Potential Lead Sources
Networking at Real Estate Clubs
Networking is critical for sourcing deals. Attending real estate clubs, meetups, and workshops can connect you with potential sellers and buyers.
Phrasing and Positioning
Effective communication is key. Know how to position yourself as an investor and phrase your offers attractively to potential sellers and buyers.
Software Features
Propelio offers a suite of tools for real estate investors, including lead lists, CRMs, and access to MLS comps. These resources can help streamline your operations and increase your success rate.
Key Takeaways
Wraparound mortgages offer a unique and often overlooked opportunity in real estate investing. By understanding the intricacies of this financing strategy, you can create profitable deals while minimizing the responsibilities typically associated with rental properties. From leveraging existing debt to managing the foreclosure process efficiently, wraparound mortgages can provide long-term benefits and financial flexibility.
Remember, the key to success lies in proper structuring, compliance with regulations, and effective networking. As you venture into this creative financing realm, you’ll discover new ways to grow your real estate portfolio and achieve your investment goals. Happy investing!
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