Wrap Around Note


An explanation of a second position note is needed
before discussing a wrap around.

 
A second position note is a note that is second in line to
another existing note (a 1st lien position) on the same
property.
A traditional "second" usually is a very small note in
relation to the value of the property.  This second
position note is created when the home buyer does not
have enough money for a down payment.
 
Here is an example:

A home is sold for $100,000 and the buyer obtains a
bank loan for 80% of the value of this home.  The buyer
needs to cover the remaining $20,000 to pay the
seller.  If the home buyer only has $10,000, then the
home seller can take back (seller carry-back financing)
a second position note for the remaining $10,000 to
complete this transaction.
 
Bank loan (1st lien position) = $80,000
Down payment = $10,000
Loan from seller (2nd position) = $10,000
Total sales price = $100,000
 
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In this scenario, the home owner is carrying a note for
$10,000 but the bank owns the 1st position for $80,000.
This note would not be purchased by some note buyers.
Here is the reason why:
 
If the home buyer stops making payments on the 2nd
position note, then nothing can be done to enforce
payment.  As long as the 1st position note is paid
(to the bank), the property can not be foreclosed on.
 
In a default situation, such as foreclosure, the holder
of the 2nd position note is
second in line to claim
his / her funds.  If the bank has to foreclose, then they
will incur expenses such as:

bullet

maintenance of the property

bullet

repairs

bullet

realtor's fees to resell the property

bullet

late fees

bullet

penalties

bullet

interest, etc.

The bank will want to collect the balance that the
buyer owed them plus all of the other expenses.
 
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For illustration purposes, let's assume that the
outstanding balance and expenses total $90,000,
but the bank only sells the home for $92,000. 
The 2nd position note holder
would receive
only
$2,000
.
 
Now a "wrap around" note can be discussed.  A
wrap around note usually is created when the
home seller takes back a note after selling his or
her home but also is making payments on an
existing note (a.k.a., underlying balance).
 
Here is an example:

A home is worth $100,000 and selling for the same
price.  The home seller currently is paying the
bank for a note owed on this property.  The balance
of this note is $20,000.
In this scenario, the home seller would sell his or
her home to the buyer using a land contract or
contract for deed and the sale price would be for
$100,000.  Also, assume that the home buyer pays
the seller $10,000 down.
  
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In this scenario, a note for $90,000 has been created
by the new buyer (
$100,000 minus $10,000 down
payment
).  At the same time, the home seller is still
paying on his or her note to the bank that has a
balance of $20,000.


Some note buyers can purchase this type of note.  The
$90,000 land contract would be purchased and the
$20,000 existing note would be paid off.  The remain-
ing balance (
the difference between the $20,000 owed
on the existing mortgage and the pay price for the
$90,000 land contract)
would be given to the note seller.
This transaction would place a note buyer in 1st posi-
tion because they are the only party that is owed any
money.
 
Here is how the above transaction is broken down:

Home sales price = $100,000
Down payment = $10,000
New note (the wrap around note) = $90,000
Balance owed to the bank by the Seller = $20,000

Again, the bottom line is:
A note buyer purchases the $90,000 note, pays
off the $20,000 note, and then gives the difference to
the note holder.
 
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Benefits of a wrap around to the buyer:

If you are a buyer with bad credit, and can NOT get approved for
a regular mortgage, then a "wrap around" can be the solution you are
seeking. 

If interest rates are higher compared to when the seller applied for
his or her mortgage, then a wrap around may allow the buyer to
"piggy-back" on the lower interest rate.  

Referring to benefit #2, a buyer could pay 7% when the market rate
is 8%.

A benefit to the seller:  a wrap around note may be a viable solu-
tion to sell the house when there is a bad housing market.  

The risks of a wrap around to the buyer:

There is an element of trust involved that can become compromised.

The buyer remits monthly payments to the seller, but the seller does
not remit these payments to pay his / her mortgage.  As a result, the lender
may take action to foreclose on the seller's property. 

Referring to risk #2, the buyer would lose ALL monies paid and the house
being paid on.

A risk to the seller:  the buyer may stop making payments.   If so, then
the seller may need to start the foreclosure process.
 

***A word to the wise regarding a due-on-sale clause:

A mortgage usually has this clause built in to the loan agreement.  This
clause allows the lender to "call" the entire loan.  In other words, the
lender has the right to demand payment in full if the house is sold.

***So, a due-on-sale clause can cause a wrap around note to become null
and void if the seller's lender exercises this option.

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